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INCEPTION REPORT:
NEPAL MACROECONOMIC MODEL (NMEM) AND
DYNAMIC STOCHASTIC GENERAL EQUILIBRIUM (DSGE) MODEL-
MODEL STRUCTURES, DATA BASE, AND SOFTWARE-HARDWARE REQUIREMENTS
IN ASSOCIATION WITH
PROFESSOR DURGA LAL SHRESTHA3
DR. VIKASH RAJ SATYAL4
MR. ROJAN BAJRACHARYA5
8 OCTOBER 2009
Executing Agency:
The Nepal Rastra Bank,
Baluwater, Kathmandu.
1
Macroeconomic Modeling Specialist/ Team Leader (International).
2
Authors would like to express their sincere thanks to Mr. Shahid Parwez, ADB Project/ Program
Implementation Officer and Dr. Nephil Matangi Maskay, Director (Research), Nepal Rastra Bank for
overall guidance, valuable discussions and comments on an earlier draft. However, the Report expresses
personal views of the authors and does not necessarily imply the views of the ADB Nepal Resident
Mission, NRB, MOF and the CBS, Nepal.
3
Macroeconomic Modeling Specialist (National)
4
Econometrician (National)
5
Information Technology Specialist (National)
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Nepal Macroeconomic Model- Inception Report
Location: 26° 22' N to 30° 27' North, 80° 4'E to 88° 12' East
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Nepal Macroeconomic Model- Inception Report
Table of Contents
Contents 3-4
Acronyms and Abbreviations 5
Project Team 6
Acknowledgements 7
Nepal at a Glance by the World Bank 8-9
1. INTRODUCTION- SCOPE, BACKGROUND AND OUTLINE 10-13
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Nepal Macroeconomic Model- Inception Report
REFERENCES 73-77
TABLE OF CONTENTS 3
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Nepal Macroeconomic Model- Inception Report
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Nepal Macroeconomic Model- Inception Report
Project Facilitators
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Acknowledgements
This Inception Report summarizes the basic objectives and scope of the project and the
major duties, responsibilities, Terms of Reference (TOR) and detailed work plan of the
Consultants viz. the International Macroeconomic Modeling Specialist Dr. Tarun Das,
National Macroeconomic Modeling Specialist Dr. Durga Lal Shrestha, National
Econometrician Dr. Vikash Raj Satyal and National Information Technology (IT)
Specialist Mr. Rojan Bajracharya.
The Report has been produced on the basis of consultations and discussions with the
principal stakeholders and the information and advice provided by them. I express my
sincere gratitude to everyone (a List of officers met is given in Annex-8) who has given
their valuable time for discussions.
I would like to thank Mr. Trilochan Pangeni, the then Executive Director, Research
Department for proving valuable backgrounds of the modeling works at the NRB. I
would also like to thank Mr. Ravindra Prasad Pandey, the present Executive Director,
Research Department and the Chairman of the Technical Committee for setting the
motion for modeling works under the project.
I would like to express my sincere gratitude and thanks to Dr. Nephil Matangi Maskay,
Director (Research), Nepal Rastra Bank for overall guidance and valuable discussions
and comments on an earlier draft. I would like to express my thanks to Dr. Bama Dev
Sigdel, Deputy Director and Dr. Ram Sharan Kharel, Assistant Director, Research
Department, NRB, for their enthusiastic cooperation, keen interest, useful discussions and
for providing relevant data and documents.
Finally, I would like to thank my colleagues- the national consultants Prof. Durga Lal
Shrestha, Macroeconomic Modeling Specialist; Dr. Vikash Raj Satyal, Econometrician
and Mr. Rojan Bajracharya, Information Technology (IT) Specialist for providing vital
inputs for preparation of this report.
It is needless to mention that the report expresses my personal views and I am solely
responsible for any errors and omissions.
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Nepal Macroeconomic Model- Inception Report
Source: Nepal at a Glance, by the World Bank, dated the 24th Sept 2008.
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Nepal Macroeconomic Model- Inception Report
INCEPTION REPORT:
NEPAL MACROECONOMIC MODEL (NMEM) AND
DYNAMIC STOCHASTIC GENERAL EQUILIBRIUM (DSGE) MODEL-
MODEL STRUCTURES, DATA BASE, AND SOFTWARE-HARDWARE REQUIREMENTS
IN ASSOCIATION WITH
“Would you tell me please, which way I ought to go from here?” asked Alice.
“That depends a great deal on where you want to get to.” said the cat.
“I don’t much care where ….” said Alice.
“Then it does not matter which way you go.” said the cat.
Eventually Alice in Wonderland realized that it does matter a great deal to know “where
to go” and “how to get there”. Similarly, in budgeting, planning and monetary
programming, it is important to know the vision, mission and basic goals of an agency;
the scope of its activities in terms of exact inputs, outputs and outcomes in the medium
term, and how to achieve these activities with least resources. Modeling and projections
help to have a clear vision by the planners and facilitate preparation of sound strategic
business and financial plans by a budgetary or monetary agency.
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Nepal Macroeconomic Model- Inception Report
An ideal model should preferably be less complex but comprehensive and dynamic,
internally consistent with unique and stable solutions, and should be easily specified,
identified, estimated, tested and calibrated with the help of reliable data, computer
capacities, simple algorithms and simple statistical/ econometric techniques. A Model
should be continually tested, calibrated, monitored, reviewed, updated, simulated and
improved to make it more realistic over time.
The task of the International Macroeconomic Modeling Specialist is to deal with the
Component-B of a wider project called Nepal: Strengthening Capacity for
Macroeconomic Analysis - TA-7165 (NEP), which is being funded by the Asian
Development Bank (ADB). The TA will enhance the Government’s capacity for
economic policy formulation based on reliable macroeconomic data and sound policy
analysis. The TA has two distinct parts viz. (a) to further improve the national statistical
system and (b) to develop and use macroeconomic models for policy simulations,
forecasting and economic planning. While component-A of the TA deals with part (a)
and is being executed by the Central Bureau of Statistics (CBS), Component-B deals with
part (b) and is being executed by the Nepal Rastra Bank (NRB).
Modeling Team comprises Prof. Tarun Das, Macroeconomic Modeling Specialist/ Team
Leader; Prof Durga Lal Shrestha, Macroeconomic Modeling Specialist; Dr. Vikas Lal
Satyal, Econometrician and Mr. Rojan Bajracharya, IT Specialist. The basic task of the
Modeling Group is to review and upgrade the Nepal Macroeconomic Model (NMEM)
built by ADB in 2005 and to build an alternative Model in the framework of a Dynamic
Stochastic General Equilibrium (DSGE) Model. The respective Terms of References
(TOR) of the consultants are reproduced in Annex-5, the respective brief CVs of the
consultants are given in Annex-6.1 to Annes-6.4 and the respective Work Plan Matrices
are given in Annex-7.1 to Annes-7.4.
Prof. Tarun Das arrived Kathmandu on Sunday, the 23 rd August 2009 and reported to Mr.
Shahid Parwez, Program/ Project Implementation Officer, ADB Mission Resident Office
at Srikunj, Kamaladi, Kathmandu on the morning of Monday, the 24th August 2009. Mr.
Parwez briefed on the overall scope and basic objectives of the project, and explained
detailed Terms of Reference (TOR). Mr. Parwez emphasized that the job of an
International Macroeconomic Modeling Specialist envisaged under the TOR is very
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Nepal Macroeconomic Model- Inception Report
Mr. Das assured Mr. Parwez that he fully understands the challenging tasks and
responsibilities of the International Macroeconomic Modeling Specialist and would
provide his best efforts and knowledge to come up to the expectations of the authorities.
However, he expects full cooperation of other members of the Modeling Group and all
possible help by the Executing Agency to provide required infrastructure support, and
relevant data and information in time.
In the afternoon of Monday, the 24th August 2009, Mr. Parwez organized a meeting with
Dr. Nephil Matangi Maskay, Director (Research), Nepal Rastra Bank, where local
consultants and the modeling facilitators Dr. Bama Dev Sigdel, Deputy Director and Dr.
Ram Sharan Kharel, Assistant Director, Research Department, NRB, were also present.
Details of the works plan and the role of the NRB as the EA were discussed. The NRB
was requested to set up a Technical Committee and to develop contacts with the Steering
Committee as early as possible. In consultation with Dr. Maskay, the Team Leader has
prepared a Work Plan which is reproduced in Annex-7.1.
Next day (Tuesday the 25th August, 2009) International Consultant had an opportunity to
meet the then Executive Director Mr. Trilochan Pangeni who provided valuable insights
on the modeling works at the NRB. Subsequently, on Wednesday, 2nd September 2009
the International Consultant met the present Executive Director Mr. Ravindra Prasad
Pandey, who is also the Chairman of the Technical Committee.
CBS is the Executing Agency (EA) for component A of the TA and NRB for component
B. Both components of the TA will be implemented in close coordination with other
relevant Government agencies, including MOF, NPC, and other line ministries and
departments. Until a Focal Officer is decided by the Technical Committee, Dr. Nephil
Matangi Maskay, Director (Research Department), Nepal Rastra Bank, has been kind
enough to take the responsibility for overall supervision and coordination, and to oversee
the day-to-day implementation of the TA activities on modeling, to maintain close
coordination with all relevant stakeholders, and to manage the consultants’ inputs.
For both the components, a Steering Committee will be formed—chaired by the relevant
NPC Member and comprising representatives of MOF, NRB, CBS, and other relevant
line ministries—to provide overall policy guidance for implementation of the TA,
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Nepal Macroeconomic Model- Inception Report
monitor progress, and take necessary actions to facilitate implementation of the TA. In
addition, two Technical Committees (TCs) will be formed to provide technical advice
and guidance on the respective TA activities. For component-B on Modeling works, TC
will be chaired by the Executive Director (Research), NRB and comprise representatives
of MOF, NPC, and other agencies. The technical committee will also coordinate with
other macroeconomic modeling activities; including the proposed UNDP supported
macroeconomic modeling for monitoring the MDGs.
With this brief introduction on modeling and project background, the rest of the report
has 9 additional sections and 9 Annexes. Section-2 deals with both global and domestic
economic context of modeling. Section-3 makes a critical appraisal of the current state of
the Nepalese economy, its development challenges, problems and prospects, and its
inherent strengths, weakness, opportunities and threats (SWOT analysis). Section-4
makes a critical review of the macroeconomic modeling works for Nepal. Section-5
describes alternative macroeconomic models and building blocks for an operational
macroeconomic model for Nepal. Section-6 describes an analytical framework of a
general equilibrium model for Nepal. Section-7 deals with specific work plans and brief
descriptions of the activities of the consultants during the project period.
The report is then followed by selected references and nine Annexes. Annex-1 and
Annex-2 present trends of major macroeconomic variables and poverty and other social
indicators for Nepal. Annex-3 makes a critical review of basic characteristics, types and
technical structures of various macroeconomic models. Annex-4 provides the complete
list of variables and data requirements for the specification, test and calibration of the
upgraded Macroeconomic Model and the Dynamic Stochastic General Equilibrium type
of model for Nepal. Annex-5 reproduces the respective Terms of Reference (TOR) of the
consultants as specified under the ADB Project (TA-7165-NEP) on Nepal: Strengthening
Capacity for Macroeconomic Analysis. Annex-6 provides brief curriculum vitae of the
consultants, while Annex-7 provides the respective Work Plan Matrices of the
Consultants.
Annex-8 presents the broad features, licensing conditions or commercial and government
volume contracts for the E-Views 6 Software which is recommended by the modeling
team for estimation, test, calibration, forecasting and simulation the Nepal
macroeconomic models. Annex-9 provides a list of officers who were consulted to
prepare this report.
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Before reviewing modeling structures, it may be useful to provide a brief account of the
global economic situation and the current state of the Nepalese economy.
It is well known that the global economy is presently passing through a critical
conjecture. It was adversely affected by three worst crises in fuel, food and financial
sectors (called F-3 Crisis) in a single year in 2008 - the first massive F-3 crisis in the last
70 years since the great depression in 1930s. Both the advanced and developing countries
have adopted various monetary and fiscal stimulus packages (such as cuts in central bank
policy interest rates, continued provision of bank liquidity, credit easing, provision of
public guarantees, bail outs and bank recapitalization etc.) to boost both investment and
consumption, output and employment. In their latest World Economic Outlook (WEO)6
of October 2009, the International Monetary Fund (IMF) concludes that although the
global economy has started to pull out of the unprecedented recession, recovery is
expected to be weak and slow, and jobless for sometime, as financial systems remain
impaired, support from public policies will gradually have to be withdrawn, and
households that suffered asset price busts will continue to rebuild savings.
As per the IMF projections made in the WEO October 2009, global growth is expected
to reach about 3 percent in 2010, following a contraction in activity of about 1 percent in
2009 (Table 2.1). During 2010–14, global growth is expected to be just above 4 percent,
appreciably less than the 5 percent growth rates in the years just ahead of the crisis.
Achieving this turnaround will depend on stepping up efforts by the governments of both
developed and developing countries to heal the financial sector, while continuing to
support demand with monetary and fiscal easing.
Growth projections in emerging Asia have been revised upward to 6.2 percent in 2009
and 7.3 percent in 2010. The upgrade owes to improved prospects in China and India, in
part reflecting substantial macroeconomic stimulus; and a faster-than-expected
turnaround in capital flows. However, the recent acceleration in growth is likely to peter
out unless there is a recovery in advanced economies.
6
World Economic Outlook- Sustaining the Recovery, October 2009, IMF Washington D.C.
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Table-2.1 IMF WEO (Oct 2009) Projections (Annual Growth Rate in Percentage)
Source: World Economic Outlook- Sustaining the recovery, October 2009, International Monetary
Fund, Washington D.C.
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As is evidenced by table 2.2, exports of goods and services and external transfers
(particularly grants and workers’ remittances) have significant contributions to GDP. The
table further indicates that the external flows were not adversely affected by the global
financial crisis and the economic slowdown.
Nepal’s total trade (exports plus imports) of goods and services as percentage of GDP
increased from 45 percent in 2007 to 46 percent in 2008 and further to 48 percent in
2009. Gross flows on current account (i.e. total inflows plus outflows on goods, services,
income and transfers) as percentage of GDP increased from 66 percent in 2007 to 71
percent in 2008 and further to 78 percent in 2009. Similarly, gross flows (inflows plus
outflows) on both current, and capital and financial account as percentage of GDP
increased from 70 percent in 2007 to 76 percent in 2008 and 85 percent in 2009.
The Nepalese economy was least affected by the initial adverse effects of global financial
crisis. The reasons include the following:
(a) Nepal’s 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.
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Economic Growth
(a) Although the initial global financial crisis did not have much adverse impact on
the Nepal’s financial sector, the real sector growth in 2008/09 has been affected
adversely due to domestic factors such as unfavorable monsoon and labor unrest.
Based on the data available for the first six months of the fiscal year 2009, the Central
Bureau of Statistics (CBS) has estimated the real GDP growth rate at basic prices is
expected to decelerate from 5.3% in FY2008 to 3.8% in FY2009. The slowdown is
expected to be broad-based, encompassing agriculture, industry and services. The
agriculture sector is expected 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.
(b) There is acceleration of the consumer price inflation which is presently running
around 13 percent due to high food prices. The stock market is bearish in general.
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.
In recent years Nepal made significant progress toward sustainable economic growth and
is committed to the so-called LPG (viz. liberalization, privatization and globalization).
Government priorities over the years focused on the integrated development of
agriculture, industry, transportation and communications. Agriculture remains Nepal's
principal economic activity, employing 70% of the wok force and contributing 33% to
GDP. Rice and wheat are the main food crops. Out of total land, only 20% is cultivable;
another 33% is forested; and the rest is mountainous.
The performance of the Tenth Plan was mixed. Significant progress was made in the
areas of MDG indicators including poverty reduction, but the achievement on economic
growth was below expectations.
The Tenth Plan had targeted normal economic growth rate to be an annual 4.3 percent on
an average (agricultural sector 2.8 and nonagricultural sector 5.2). However, during the
Plan period the average annual growth rate remained 3.4 percent (agriculture sector 2.67
percent and the non-agriculture sector 3.79 percent). Some structural changes in the
economy were observed. Over the period, the contribution of agricultural sector in GDP
declined from 37.4 percent to 33.1 percent, while that of non-agricultural sector increased
from 62.6 percent to 66.9 percent. Among the non-agriculture sector, trade and
commerce, hotel and restaurant performed better,
During the plan period, the total consumption, on an average, remained 89.84 percent.
The gross capital formation remained 25.57 percent of the Gross Domestic Product.
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Similarly, the Gross Domestic Savings remained an annual average of 10 percent and
Gross National Saving 28.1 percent of the Gross Domestic Product. Although no change
was seen during the Tenth Plan period in the Domestic Saving and Consumption, a
positive change in Gross Capital Formation and Gross National Savings was observed.
During the plan period there was some deterioration in the current account surplus, whereas
an improvement has been observed in the balance of payments position
The average annual inflation measured by the national consumer price index, was
contained at the average rate 5.5% during the Tenth Plan with a peak of 8% reached in
2005/06 mainly because of rise in petroleum product prices. Transport, communications
and housing recorded the highest price rises during the Plan period.
During the Tenth Plan, despite deceleration of the exports growth and rising trade deficit,
the current account and overall balance of payments position remained strong due to
increasing inflows of remittances.
As the Tenth Plan came to an end in July 2007, after the culmination of a series of
historical struggles in the form of the 2006 People's Movement, the National Planning
Commission (NPC) prepared a three year Interim Plan from FY 2007/08, consistent with
the people’s aspirations, the Interim Constitution, and the Common Minimum Program of
the government. For the first time in the country's history of plan formulation, the NPC
targeted to more than 70 VDCs of 30 districts, carrying out direct observation and
collecting people's suggestions. Similarly, at the central level, consultations were held
with all stakeholders.
The main objective of the Interim Plan is to realize changes in the life of people by
reducing poverty and unemployment and establishing sustainable peace. It puts special
emphasis on increasing public expenditure for employment generation, peace building,
reconstruction, rehabilitation, reintegration, inclusion, and revitalization of the economy.
Similarly, the Plan provides special attention to women, the poor, weaker sections of the
society and development of remote areas.
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The following table summarizes the quantitative targets of the three year Interim Plan.
However, a joint study by the National Planning Commission of Nepal and the UNDP
Country Team in Nepal indicates that Nepal remains off-track as regards the MDG
targets on universal primary education and incidence of HIV/ AIDS, malaria and other
diseases (NPC/ UNDP 2005).
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As the country's investment requirements far exceed the internal savings, access to
external capital, in the form of loans or grants, is inevitable. However, Nepal has
managed external debt very well. The external debt to GNI declined from 52 per cent in
FY2000 to 38 per cent in FY2006, and external debt service (to exports of goods and
services ratio) declined from 9.7 per cent to 5.1 per cent over the same period. Nepal's
external debt stock is composed of high levels of concessional loans with long maturities
and nominal interest charges. The share of short-term debt in total debt is negligible,
although in recent years it has shown an upward trend. The country has foreign exchange
reserves, equivalent to about 7.5 months imports cover.
The Central Bureau of Statistics (CBS) of Nepal has estimated that the Real Gross
Domestic Product (GDP) would grow by 3.8% in 2008-2009, compared to 5.3 percent
recorded in 2007-2008. However, as per the assessment made by the ADB7, the growth
rate is likely to be lower due to poor winter crop, deceleration in remittances inflow and
slower industrial growth caused by continued power shortage and long-term structural
weaknesses in the economy. The deceleration of the growth rate is also partly due to the
global economic slowdown as discussed earlier.
Overall annual point-to-point consumer price inflation at the end of ten months of 2008-
2009 stood at 12.9% driven by high food prices and higher salaries and wages. With poor
winter crop output, it is unlikely that inflation will moderate significantly for the rest of
the year. In general, it was observed in the past that there exists a high positive
correlation between inflation rates in India and Nepal. However, in the recent months,
Nepalese inflation has not followed the decelerating trends of the Indian overall inflation,
due to high food prices in both India and Nepal.
7
Quarterly Economic Update- Nepal, Vol.VI, No.1, June 2009, ADB.
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Money supply is expanding at a lower rate than last year, and the momentum in liquidity
expansion has been curtailed by large share subscriptions of commercial banks. But,
given a fixed exchange rate with Indian Rupee since 1991 and high international prices of
major imports of Nepal (viz. food items and petroleum products), Nepal Rastra Bank
(NRB) has a difficult task of controlling inflation without impeding much-needed
investment for sustaining economic growth.
Tax reforms introduced in the past have led to an improvement in revenue mobilization
and a healthy fiscal position, although it is partly due to low capital spending.
In the external sector, both the current account and the overall balance-of-payment
positions remain in surplus, although inflows of foreign investment have been adversely
affected to some extent by political environment. Within the current account, trade deficit
continues to widen, but it is more than offset by remittances inflow and tourism receipts.
It is expected that external balance will remain favorable due to continued inflows of
remittances by Nepalese citizens working abroad.
Nepal’s commercial banks hold insignificant foreign liabilities. Consequently, the first-
round effects of the global downturn were not observed in Nepal, although the Nepalese
rupee depreciated against third currencies due to its peg to the Indian rupee. The outlook
of other channels such as trade and remittances is also optimistic, although tourist arrivals
have declined in recent months.
During the last five years the Nepalese economy had performed reasonably well with
moderate and stable economic growth, increasing per capita income, buoyant investment,
moderate inflation, low fiscal deficit and favorable balance of payments situation. But,
these favorable trends have not led to commensurate reduction of poverty in rural and
hilly areas. This implies that the so-called trickle down effects of growth had been
delayed, slow and uneven. The worldwide recent financial crisis and economic slowdown
along with domestic political transition might have further exacerbated the economic
situation in Nepal.
These trends have led to various development challenges such as how to sustain
economic growth with fiscal prudence, monetary discipline and price stability, how to
promote equitable growth and to raise the levels of living of all citizens, how to eradicate
poverty, hunger and disease and to attain other Millennium Development Goals (MDGs)
at a faster speed, and how to create enabling environment for public-private partnership
and international cooperation in the development process for improving quality and
delivery of basic public goods and services.
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MDG targets, the Ministry of Finance and the National Planning Commission, being the
coordinating Agencies, have special responsibilities to provide necessary advice and
directions to other ministries.
The core challenge for the government budget is how to adopt long-term MDG targets
within the annual and medium-term national budget constraints and priorities. MDG
strategies are both ‘needs based’ and ‘resource constrained’. The national budget must
take care of poverty reduction strategies as a guide to MDG action, and set out clear
priorities for pro-poor public expenditure and investment plans based on a realistic
assessment of the available resources and the needs of other sectors.
The country’s economic growth has remained low and needs to be reinvigorated by
increasing agriculture production and productivity and improving environment for private
investments including foreign investment. There is also need to improve institutional set
up and governance, liberalize labor laws, and improve investment climate and physical
infrastructure. Nepal’s road density is one of the lowest even among the least developed
countries. Similarly the country suffers from severe electricity shortage.
The challenge is not only of accelerating growth, but also of sharing the growth and
prosperity more broadly across the population. Building social and human capital,
creating employment opportunities and implementing affirmative actions to the excluded
groups are probably the best ways for reducing poverty and inequality in the country. If
all Nepalese people are healthy, educated, skilled and live longer, they can participate
fully, contribute more and gain from the development process..
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On the basis of above discussion, a SWOT analysis of the Nepalese economy is presented
in the following table.
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A comprehensive Macroeconomic Model can specify, test and calibrate complex and
dynamic interrelationships among major economic variables with the help of powerful
analytical, statistical and econometric tools that can be very useful for forecasting and
policy planning by the Ministry of Finance, National Planning Commission, Nepal Rastra
Bank and other departments and stakeholders both within and outside the government.
A macroeconomic model can analyze trends of both the internal and external variables in
a consistent analytical framework, and address various important issues such as
controlling inflation, tackling balance of payments problems, sustaining growth in the
medium to long term, examining inflation-growth-poverty-inequality trade-offs,
managing public debt and fiscal deficit at sustainable levels, and determining permissible
levels of monetized fiscal deficit. As observed by Clements and Hendry (1995): “ Formal
econometric systems of national economies fulfill many useful roles others than just
being devices for generating forecasts. For example, such models consolidate existing
empirical and theoretical knowledge of how economies function, provide a framework
for a progressive research strategy, and help explain their own failures”.
The basic purpose of the model is to make the projections of the following variables for
the medium term 2009/10-2013/14:
Existing economic system is complex and has close linkages with the socio-political-
external environment. Naturally a modeller needs to make certain presumptions about
these initial conditions and to build alternative scenario for future. So, a number of
questions need to be answered before an operational model can be developed:
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Nepal Macroeconomic Model- Inception Report
These questions are simple, but there are no simple and general answers. A modeller has
to make a compromise between what is theoretically and technically justified and what
kinds of data are produced by the CBS, NPC, MOF, NRB and other agencies.
Can we capture the historical process with past trends of statistical data? The answer is-
yes and no. If the past statistical data are incomplete and imperfect, future cannot be
predicted on the basis of it. Fortunately, for modellers, over the years Nepal has built up
authentic and comprehensive data bank on all sectors of the economy and these are easily
available on the websites of the MOF (www.mof.gov.np/), CBS (www.cbs.gov.np/) and
the NRB (www.nrb.org.np/ ).
The best set of data available for the Nepalese economy includes the following:
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Nepal Macroeconomic Model- Inception Report
Brief descriptions of these models with their relative merits and demerits are presented in
Annex-3. It may be observed from the discussions that there does not exist a universal
model which holds good at all times and for all countries. There is also no general
agreement among the modelers regarding the choice of a particular model for a country.
Modelers welcome that “Let all the flowers bloom and flourish”.
Macroeconomic Modeling Specialist and other consultants did not have enough time to
review in details the existing data base in Nepal and the level of capacity in terms of both
skilled human resources and the information and communications technology (ICT) in
the government departments and in the Nepal Rastra Bank. Therefore, it is difficult at this
stage to indicate the types of models which will be most suitable for Nepal.
International best practices and the author’s own experiences in modeling in selected
developing countries in Asia and Africa (such as India, Cambodia, Mongolia,
Philippines, and the Gambia) lead to the following conclusions:
(o)Modelers should specify sources of data and share basic data with others.
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Nepal Macroeconomic Model- Inception Report
(q)Part of the documentation should be clear and free from statistical and
econometric jargons and mathematical squabbles for general understanding by
the non-technical audience.
(r) Stakeholders, users and policy makers should be involved in the modeling
process from the very beginning so that the model could be modified and made
more realistic.
(s) It is necessary to continually review, monitor, update, upgrade and simulate the
model to take care of changing domestic and external environment.
(t) It is better to state biases, intuitive arguments and the inherent limitations of a
model more explicitly in the model description rather than concealing.
(u)A modeler should know whom he is addressing for the presentation of his model
and who the clients for the final results are. If he is addressing senior most policy
makers, main text may concentrate on basic results and their interrelations, while
the econometric estimation details and equations with mathematical jargons may
be presented in the technical appendix.
All these dictums will be kept in view by the macroeconomic modeling specialist while
building up an appropriate model for the Nepalese economy.
Sample period for NMEM update and DSGE Model will be from FY1984/85 to
FY2006/07 since the data for 2007/8 is not final. There will be thus 23 years of time
series data. Modeling exercise based on the actual data is more realistic and reliable than
that on estimated data, and large number of observations in a time series will be better for
obtaining more robust and reliable estimates.
The major sources of the data are the Government of Nepal, MOF, NRB and CBS. The
data for final demand, prices, Balance of payment, government budget, and money can be
obtained from the Economic Survey and budget speech of MOF, Quarterly Economic
Bulletin of NRB, and, Statistical year books of CBS. In addition to them, recent data can
be obtained from official records of these offices. But due care should be taken in using
some data from different sources because they may not be consistent.
The fiscal year of the Government of Nepal ends on 15 July. For example, FY2009
includes the time period from 16, July 2008 to 15, July 2009. The unique dating
convention makes it necessary to adjust foreign variables to maintain data coherence.
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Nepal Macroeconomic Model- Inception Report
Since 1980’s, individual researchers had attempted to use statistical techniques and
econometric models for economic analysis and forecasting in Nepal.
2) In 1987, the Water and Energy Commission developed a macro model for
forecasting energy demand.
4) A similar version of the macroeconomic model was also used in the formulation
of the Eighth Plan.
5) In 1992 another macro model was developed as a part of the link model for the
South Asian Association for Regional Cooperation (SAARC) countries10 to
examine the impact of regional trade on its member economies.
9
Development Study Consultants. 1990. Policy Planning Models for the Nepalese Economy with Special
Reference to the Industrial Sector. Mimeo. Kathmandu: DSC/MOI/UNIDO.
10
Khanal, D. R. and G. N. Sharma. 1992. A Macroeconometric Model of Nepal in SAARC Link. Nagvi,
S.N.H. and S.A. Samad, eds. New Delhi: Oxford and IBH Publishing Co. Pvt. Ltd.
11
Cruikshank, E.D. and R.H. Nord. 1990. The Role of Exchange Rate Policy: The Case of Nepal.
Mimeo. Kathmandu.
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Nepal Macroeconomic Model- Inception Report
8) While the Tenth Plan was being formulated, the integrated macro and input-
output model was used to set the growth rates and the investment levels at both
the sectoral and aggregate level without disrupting macroeconomic stability.
10) A common feature of the two models is that GDP is predetermined or stipulated
before estimating individual equations. These models implicitly assume that the
supply side determines aggregate output, and they predict each endogenous
variable in a way that is consistent with the given output level.
11) There had recent attempts under technical assistance by ADB to develop a
medium a medium size Macroeconomic Model (MEM). A part of TA for
Strengthening Institutional Capacity for Public Debt Management, ADB (Ra and
Rhee 2005) supported the Government in developing a MEM in 2005– known as
Nepal Macroeconomic Model (NMEM)— on the basis of the standard Keynesian
income–expenditure approach in which gross domestic product (GDP) is
determined endogenously.
12) Apart from being used by the Government for debt sustainability analyses, Nepal
Rasta Bank (NRB) has also been using the NMEM for economic forecasting.
13) Subsequently to that Khanal and Kane (2005) had utilized a MEM to analyze
reduction of domestic poverty, and
14) Bhattarai (2007) had produced an applied dynamic general equilibrium model for
Nepal.
15) In recent years Nepal Rastra Bank has engaged itself actively for developing its
own MEM which would be consistent with the vision and mission of the Bank.
The model was developed by the Macroeconomic Modeling Unit (MMU) of the
NRB (2007), Research Department’s Economic Analysis Division as a part of its
macroeconomic modeling activities.
From the above review it follows that the state of the macroeconomic modeling in Nepal
is still at an experimental and learning stage. There are a few examples of
macroeconomic modeling for the purpose of policy planning and formulation of
12
Alamgir, M., and S. Ra. 2001. Nepal: Debt Sustainability and Country Risk Analysis. Manila:
ADB.
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Nepal Macroeconomic Model- Inception Report
economic plan. But these were not done on a sustainable, comprehensive and continual
basis. There was also lack of adequate capacity building in the respective agencies.
Besides, the utility of NMEM has become limited due to major structural changes in the
Nepal’s economy, and major revisions of key macroeconomic data (such as National
Accounts, Price Statistics, Government Finance Statistics and the Balance of Payments
over the years) due to changes in base period and basic concepts. Therefore, the NMEM
developed by ADB needs to be reviewed and upgraded. In addition, other econometric
models such as the Dynamic Stochastic General Equilibrium (DSGE) model need to be
developed to examine the relative merits and demerits of both these models.
Considerable efforts are, therefore, required for the development of new modeling
techniques with a focus on the direct and practical policy applications by the Nepal
Rastra Bank, Ministry of Finance and the National Planning Commission (NPC).
The basic purpose of the present technical assistance of the ADB is to remove these
deficiencies in macroeconomic modeling and to strengthen technical capability in the
NRB, MOF, NPC and CBS for model building and its use for policy planning.
The basic purpose is to build an appropriate and stable model, depicting the underlying
structure of the Nepalese economy, which can be used to forecast major macro economic
variables for both the short-term (one year) and medium term (five years) for preparation
of budget and national plan and formulation of monetary and fiscal policies. The
projections will also form the basis for preparing the macroeconomic and fiscal envelope
by the Nepal Rastra Bank to be provided to the Ministry of Finance for pre-budget
consultations and requirements.
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Nepal Macroeconomic Model- Inception Report
The basic structures of these sub-models and their interrelations are depicted in the form
of a flow diagram in Box-6.1. The linkages between key aggregates of the national
accounts and the balance of payments flows can, by the use of symbols, be summarized
algebraically within a savings/investment framework.
R = Revenue = T + NT
T = Tax revenue
NT = Nontax revenue
GR = Grants
GEXP = Government expenditure and net lending = G + GK
G = government consumption expenditure
GK = GCE + ND
GCE = Government capital expenditure
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Nepal Macroeconomic Model- Inception Report
ND = Net lending
GFD = Gross Fiscal Deficit
= (R+GR) - GEXP
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Nepal Macroeconomic Model- Inception Report
National Accounts
Real Sector (Supply Side) CENTRAL GOVERNMENT
GDP = Σ GDPi Revenues
Where GDPi = GDP of i-th sector • Taxes and non-taxes
• Grants
Demand/ Expenditure Side Expenditures
NMEM’s
• Private consumption • Current
• Gen. govt. consumption • Capital
• Gen. govt. investment Overall balance
• Private investment Financing
• Exports of goods and • Domestic financing (net)
non-factor services • Banking system
• Imports of goods and • Nonbanking sector
non-factor services • External financing (net)
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Nepal Macroeconomic Model- Inception Report
Interrelationship between the internal and external sectors of an economy can be seen in
greater detail by distinguishing between the private and government sectors. Private
saving and investment (Sp and Ip) and government saving and investment (Sg and Ig)
are identified as:
Use of the definition of the external current account from equation (1) then gives:
CAB = (Sp–Ip) + (Sg–Ig) = S–I (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.
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 must—by definition—be matched
by a change in net claims on the rest of the world.
Where
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.)
TRANB = current transfer balance (official grants, private grants, remittances)
For Nepal, in general, TB and SB are negative, while FIB and TRANB are positive.
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Nepal Macroeconomic Model- Inception Report
While keeping these basic identities and macroeconomic balance equations intact,
various variables in the model will be categorized either as exogenous variables or
endogenous variables. While exogenous variables will be determined outside the model,
suitable econometric relations will be specified for the endogenous variables on the basis
of standard economic theories.
The proposed Work Plan Matrices of the Consultants are presented in Annex-7.1 to
Annex-7.4. Major Work Plan Milestones are summarized below:
10. Conduct multi-stakeholders’ seminars/ workshops on the features of the two models by
15 May 2010
11. Preparation of macroeconomic and fiscal envelope for the Ministry of Finance as pre-
budget inputs for preparation of the Budget for 2010-2011 by 31 May 2010
14. Conduct seminars/ workshops on the features of the two models by 30 Sep 2010
15. Provide on-the-job training to three staff from each of the agencies— NRB, CBS, NPC,
MOF and the Department of Economics, Tribhuvan University, and other relevant
agencies (staff will be selected in close coordination with the executing agency, Steering
Committee, and the Technical Committee) by 30 Sep 2010.
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Nepal Macroeconomic Model- Inception Report
In 2005 ADB (Ra, Sungsup and Chang Young Rhee 2005) developed the Nepal
Macro-economic Model (NMEM) and simulated the model to carry out alternative
scenario analysis. The model was also calibrated to measure the economic costs of
conflict in terms of the effect of declining development expenditures on economic growth
(Ra, Sungsup and Bipul Singh 2005).
(a) Model considers only the demand side of GDP, but does not consider the supply
side of the real sectors.
(b) Similarly, money, credit and price blocks were not fully developed and did not
consider the supply side and the role of expectations.
(c) The Government block was the weakest block with only equation for the non-tax
revenue and all other variables were defined by simple accounting identities.
Basically, all the fiscal variables such as taxes, current and capital expenditure are
treated as policy variables and left to be decided by the policy makers. This is not
a very convincing assumption because taxes and government expenditures also
depend on economic prospects, composition of GDP and many other variables.
(d) Similarly, balance of payments block were not well developed. It considered
only merchandise exports and merchandised imports but did not endogenize the
other components in the current account (such as services and remittances). In the
capital account, loans and amortization was endogenized, but the underlying
econometric relations are less convincing.
(e) The model also needs to be updated and upgraded on the basis of new data
available for the national accounts and balance of payments.
The NMEM will be reviewed more critically and modifications will be suggested in the
next report. While doing so, due consideration will be given to the availability data base,
statistical test and calibration techniques, computer algorithms, and available hardware
and software capabilities, and technical manpower in the NRB, MOF and other budgetary
agencies which are likely to use the updated NMEM for budgeting, planning and
monetary and financial programming.
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Nepal Macroeconomic Model- Inception Report
The model has been described fully with its relative merits and demerits in terms of
objectives, data requirements and test and calibration techniques in section 3.13 in the
Annex-3. As the name indicates, DSGE models are dynamic, studying how the economy
evolves over time. They are also stochastic, taking into account the fact that the economy
is affected by random shocks such as technological change, fluctuations in the price of
oil, or errors in macroeconomic policy-making.
International best practices like the ECB Model and the USA Model will be studied and
suitable model will be formulated and estimated for forecasting and planning by the
NRB, NPC and the Ministry of Finance.
The consultants shall work in close collaboration with the concerned authorities in the
government department viz. MOF, CBS, NPC and the National Rasta Bank with a view
to transferring knowledge and equipping the staff with the skill required to manage and
maintain the models in future. Consultants will demonstrate the use of the models by
simulating actual policy questions raised by the authorities.
After the Models have been fully developed, macroeconomic modeling experts shall
carry out a series of simulations to check for consistency, predictability and reliability of
both the models, and shall validate both the models at multi-stakeholders workshop.
Macroeconomic modeling experts will also advise the authorities on the most appropriate
hardware and user-friendly software package for the purpose of maintaining the models.
In consultation with the Team Leader, local econometrician and the local IT Specialist
jointly made a Rapid Survey on the current status of ICT capabilities in the MOF, CBS,
NPC and NRA. As per their assessment, all the four agencies have rich database, well
developed website, and reasonable hardware and software capabilities. However, licenses
of major software have expired and the software is outdated and need upgrading.
Agencies do not have uniform operating systems and software capabilities. All these
issues will be studied in details and suitable recommendations will be given.
The main observations of the Consultants drawn from the Rapid Survey are summarized
below:
a) Data Bank and Warehouse: All four agencies regularly update their database and
maintain soft version of data in various software depending on the size and nature of the
database. CBS maintains database mostly in MS-Excel, Oracle, STATA and SPSS; NRB
in MS-Excel and SPSS; MoF in Oracle and MS-Excel; and NPC in SPSS, Oracle and
MS-Excel. For time-series data on major Macro variables, all four agencies use MS-
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Nepal Macroeconomic Model- Inception Report
Excel and share their data via emails. However, time interval and frequency of data
publication varies from agency to agency depending on the nature of data. There is no
uniformity in the storage and software format among the agencies.
b) Capacity for Data Analysis: Capacities of agencies differ in terms of data analysis
skill. CBS is very competent in statistical analysis but lags in macro-econometric
forecasting. NRB is equipped with both statistical techniques and limited macro-
econometric modeling skills. NRB staffs are technically competent and use econometric
methods in course of their researches, but such activities are not systematically followed
due to pressures from routine works. NPC has limited capacity on statistical analysis but
has experience of modeling exercises that were discontinued due to work pressures and
limited designated staffs. MOF is less competent in statistical analysis and econometric
modeling skills as compared to other agencies.
c) Capacity for Data Retrieval: Capacities of the four agencies differ in terms of data
retrieval. While four agencies have capacity to retrieve data from MS-Excel, CBS, NRB
and NPC are partially equipped to retrieve data from SPSS and Eviews. They also have
some knowledge on how to transfer the database from one software to another software.
d) Data Availability in Web: All four agencies have their own websites, which are
updated on regular basis to upload new data. The data are generally uploaded either in
MS-Excel format or in Adobe Reader files.
e) Hardware Capacity: All four agencies do have sufficient computers of good quality
that are sufficient to run software programs like EXCEL, SPSS, STATA and Eview and
to use the facility of internet/ emails.
g) Human Resource: CBS staffs have very good statistical skill but very few of them
have the experience of modeling. NRB staffs, in general, possess very good statistical and
modeling skill. NPC has very limited human resource but the available few are very
competent in statistical and modeling shill. MOF has a very small pool of human
resource having sufficient statistical and modeling skills.
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Nepal Macroeconomic Model- Inception Report
As discussed earlier, substantial time will be spent to prepare manuals and full
documentation on basic concepts, structure of the models, data base, computer
algorithms, test and calibration techniques. portion, so that any other group can test,
calibrate and run the model, even after the present modelers and consultants have left the
modeling project. Once the Models are fully developed and calibrated, results will be
presented in the multi- stakeholders Workshops.
This is the Inception Report being prepared by the International Modeling Specialist in
consultation with the major stakeholders and vital inputs from the local consultant. The
Inception Report is expected to be completed by the 10th September, 2009, well before
the stipulated time of one month as envisaged under the Terms of Reference. List of
officers consulted for preparation of this report is giver in Annex-8.
The modeling works with all its components are required to be completed in six person
months (132 working days) on intermittent basis in four phases during 15 months from
August 2009 to October 2010. The Work Plan Matrices of the Consultants presented in
Annerx-6.1 to Annex-6.4 clearly indicate the distinct four phases of the work which will
be completed within stipulated time. The Progress Report will be submitted after
completion of each phase of works.
At the end of the Project, a Terminal Report will be prepared indicating the overall scope
and achievements of the project, constraints faced, lessons learnt, issues and challenges
for way forward, and suggested roll out plan so that the project comes to a logical end.
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Nepal Macroeconomic Model- Inception Report
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Nepal Macroeconomic Model- Inception Report
can affect trade with the rest of world by changing the relative prices with
other countries.
The Nepal Macro-economic Model (NMEM) was tested and calibrated on the basis of
time series data for the sample period from FY1975 to FY2004. Then the model was
simulated to carry out alternative scenario analysis for formulation of the Tenth Plan. The
model was also calibrated to measure the economic costs of conflict in terms of the effect
of declining development expenditures on economic growth (Ra, Sungsup and Bipul
Singh 2005).
There are 5 building blocks in the NMEM viz. final demand, prices, credit and money,
government, and the balance of payments blocks. Final demand is the sum of private
consumption, government consumption, private fixed investment, government fixed
investment, increase in stock or inventory, and net exports. In NMEM, development
expenditure is a determinant for the private fixed investment, public fixed investment and
public consumption.
Limitations of the Model of the Model have already been discussed in section 7.1. So
these are not repeated here. In brief Model considers only the demand side of GDP, but
does not consider the supply side of the real sectors, which put basic constraints on the
growth and development of a developing country like Nepal. In addition, monetary,
financial and price blocks, government block, and balance of payments block were not
fully developed and did not consider the supply side and the role of expectations of
economic agents. The model also needs to be updated on the basis of new data available
for the national accounts and balance of payments.
The utility of NMEM in the national polity analysis has been limited due to the
following reasons:
− The structure of Nepal’s economy has changed significantly. Agriculture’s
contribution to GDP has declined fast whereas the services sector’s contribution has
grown rapidly compared to other sectors of non-agriculture sectors. It is interesting to
note that the industry’s share of GDP has remained more or less unchanged. The
national accounts also underestimate certain incomes, such as migrant workers’
remittances, which have grown sharply since 2004.
− There have been some major revisions of basic concepts and standards of key
macroeconomic variables such as national accounts, government finance, balance of
payments and prices since the NMEM was developed.
− In view of these changes, it is necessary to upgrade the NMEM for analytical work
and macroeconomic forecasting.
In the following section, we specify a modified and upgraded macroeconomic model for
Nepal. While doing so, due consideration has been given to the availability new data
base, up-to-date statistical test and calibration techniques, computer algorithms, and
available hardware and software capabilities, and technical manpower in the NRB, MOF
and other budgetary agencies which are likely to use the updated NMEM for budgeting,
planning and monetary and financial programming.
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Nepal Macroeconomic Model- Inception Report
Table-8.2
2. Government
Consumption
3. Private
Fixed
Investment
4. Government
Fixed
Investment
5. Exports of
goods and
services
6. Imports of
goods and
services
7. Consumer
Price Index
8. GDP
Deflator
9. Net Foreign
Assets
10.Private
Domestic
Credit
11.Government
Domestic
Credit
12.Non-tax
Revenue
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Nepal Macroeconomic Model- Inception Report
13.Merchandis
e Exports
14.Merchandis
e Imports
15.Foreign
Loans and
Official
Grants
16.Amorti-
zation
17.Foreign
Loan
Disburse-
mint
18.Grant
Disburseme
nt
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Nepal Macroeconomic Model- Inception Report
As described in Section 6 earlier the proposed model has the following blocks:
Real GDP at constant factor cost will be projected for the broad sectors
of the economy. List of variables, their types and notations are
indicated in the following table:
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Nepal Macroeconomic Model- Inception Report
Data Base
The basic data on selected variables for the period from the fiscal year
1984/1985 (annual data the year 1984/1985 ending 15 July 1985) to
the fiscal year 2007/2008 (annual data for the year 2007/2008 ending
15 July 2008) will be obtained from the respective primary sources i.e.
national accounts from the CBS, balance of payments and monetary
and financial statistics from the NRB and the public finance statistics
from the MOF.
Methodology
To start with, we estimate the average historical growth rate for each
sub-sectors of GDP viz. GDPAG, GDDMANF, GDPMINQ, GDPELEC,
GDPCONST, GDPTRADE, GDPTRANS, GDPFIN and GDPCSP. The
following three kinds of growth rates are calculated on the basis of the
past data from 1984/1985 to 2007/2008.
The IMF uses the Least-squares growth rates to forecast the country
growth rates in their World Economic Outlook (WEO) published twice in
a year, wherever their is past data for at least 9 years to permit a
reliable calculation. The least-squares growth rate, r, is estimated by
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
Yt = Yo (1 + r)t
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Nepal Macroeconomic Model- Inception Report
The exponential growth rate between two points in time for a variable
is calculated from the following equation
r = Ln (Yn /Y1)/n
where Yn and 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.
In general, the least squares trend growth rate is expected to be lower than the
exponential growth rate, which in turn is expected to be lower than the average annual
growth rates for most of the variables.
It may also be possible that annual growth rates are highly volatile with high standard
deviation (SD) and co-efficient of variation (CV), and therefore the average annual
growth rate cannot hold good for the medium and long term.
The projections of sectoral value added for the years 2009-2015 are done on the basis of
the trend growth rate, which happens to be the minimum of these three types of growth
rates. However, if for any variable, there is high CV (say exceeding 100%), the projected
growth rate is modified on the basis of the following formula:
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Nepal Macroeconomic Model- Inception Report
The same methodology is used to project net indirect taxes (i.e. indirect taxes less
subsidies and transfers). Thus we have,
Yt = Yo (1 + r)t
Demand side is projected at current market prices because decisions by economic agents
are always made on the basis of current market prices. List of variables, their types
and notations are indicated in the following table:
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Nepal Macroeconomic Model- Inception Report
Nominal GDP is determined by the usual balance equation. The other equations are
specified below.
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Nepal Macroeconomic Model- Inception Report
GRt = Grants are estimated on the basis of historical growth rates as described in earlier
section adjusted by current information by the government
INT = Interest payments are estimated on the basis of projected profile of domestic and
external public debt and negotiated terms and conditions for interest payments
OC = CG-WS-INT
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Nepal Macroeconomic Model- Inception Report
GRt = Grants are estimates on the basis of historical growth rates as described in section
8.2.1 adjusted by current information by the government
Ln (TRPt) = α + β 1 Ln(GDPNt) + β 2 Ln(TRPt-1) + β 3 Time
Ln (REMt) = α + β 1 Ln(GDPNt) + β 2 Ln(REMt-1) + β 3 Time
TRBt = GRt + TRPt + REMt
DISBt and AMORTt are estimated on the basis of projected profile of external public
debt and negotiated terms and conditions for disbursement and repayments of principal.
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Nepal Macroeconomic Model- Inception Report
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Nepal Macroeconomic Model- Inception Report
The main objective of the model is to conduct policy analysis and to forecast major
macroeconomic variables for the immediate future and the medium
term which can be used to prepare the government budget,
macroeconomic plan, monetary program, and to formulate budgetary,
fiscal, monetary and real sector policies by the Ministry of Finance,
Nepal Rastra Bank and the National Planning Commission. The model can
also decompose macroeconomic variables for explaining their fluctuations (shocks), both
in history and forecast. Because of its designs, such as micro-foundations, dynamics,
uncertainty and rational expectations, a potential use of the model is the evaluation of the
impact of fiscal and monetary policy on social welfare (such as inflation, poverty etc.).
Other uses of the model include the estimation of non-observable variables such as the
natural interest rate, the potential output, the real exchange rate equilibrium and the
natural unemployment rate for the Nepalese economy. The main advantage of the model
is its ability to estimate all the variables simultaneously.
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Nepal Macroeconomic Model- Inception Report
As the name indicates, DSGE models are dynamic, studying how the economy evolves
over time. They are also stochastic, taking into account the fact that the economy is
affected by random shocks such as technological change, fluctuations in the price of oil,
or errors in macroeconomic policy-making. Traditional macro-econometric forecasting
models used by central banks in the 1970s estimated the dynamic correlations between
prices and quantities in different sectors, and often included hundreds of variables.
Since DSGE models are technically more difficult to solve and analyze, they cannot deal
with sectoral details as given in the previous section, and would include limited number
of variables. DSGE models provide logical consistency and spell out the essential aspects
of the economy viz. preferences of economic agents, technology used for production,
and institutional framework for monetary, fiscal and external sector policies.
The best example of DGSE models include the Smets-Wouters model, developed by the
European Central Bank (ECB), to analyzes the economy of the Eurozone as a whole
(without analyzing individual European countries separately). Another partial DGSE
model is used by the staff of the Joint Committee on Taxation to model the
macroeconomic effects of proposed tax legislation in the United States of America.
With limited database and resources (in terms of technical manpower, hardware and
software requirements, and Finance) and no previous experience of DGSE modeling such
a leapfrogging may not be feasible for Nepal. So we make an attempt to develop a simple
DGSE Model for Nepal. Here we present the basic structure of an operational DSGE
Model for Nepal. The Model will be fully developed in the course of the modeling
exercises by the consultants after examining fully the available data base, estimation
techniques and computer algorithms for test, calibration, projections and simulations.
As in the case of NMEM described in the previous section, the DSGEM will have five
interrelated blocks as follows. However, unlike in the NMEM, demand equations in this
14
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Nepal Macroeconomic Model- Inception Report
model will take into account the behavior, preferences and expectations of the economic
agents and the production side will consider technological equations.
The model would use annual time series data for the period from 1985
to 2008 obtained from the CBS, MOF and NRB. The model will be
calibrated and tested by EVIEWS 6.0.
Methods of estimation
15
If one of the equations in the system is miss-specified and estimate the parameters
using single equation methods, only the miss-specified equation will be poorly
estimated. If system estimation techniques are employed, the poor estimates for the
misspecification equation may "contaminate" estimates for other equations.
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Nepal Macroeconomic Model- Inception Report
Yt = βXt + Ut (1)
Ut = ρUt-1 + Vt (2)
The parameter ρ is the first-order serial correlation coefficient. In
effect, the AR(1) model
incorporates the residual from the past observation into the regression
model for the current observation. For example, the EVIEWS software
automatically uses the following equation to transform the linear
model into a nonlinear model:
Real GDP at constant factor cost will be projected for the broad sectors
of the economy. List of variables, their types and notations are
indicated in the following table:
16
For details consult EVIEW user’s guide book or EVIEW help.
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Nepal Macroeconomic Model- Inception Report
Where H stands for human capital indicating skill of the labor force. It is estimated by
Demand side is projected at current market prices because decisions by economic agents
are always made on the basis of current market prices. List of variables, their types
and notations are indicated in the following table:
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Nepal Macroeconomic Model- Inception Report
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Nominal GDP is determined by the usual balance equation. The other equations are
specified below.
Private consumption (CP) will be estimated by the following relation by pooling both
time series and cross section data:
Linear C = α + β Y
Log linear Log C = α + β Log Y
Semi log Log C = α + β Y
Log Inverse Log C = α + β /Y
Log Log Inverse Log C = α + β 1 Log Y+ β 2 / Y
This Engel elasticity will be taken as given to estimate price elaticity (β 2) on the basis of
time series data.
For fixed investment, we will use the traditional lagged investment model. Using
incremental capital/output ratio (h), gross investment is given by
Exports and imports of goods and services will be estimated by the same equations as in
the NMEM model:
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Nepal Macroeconomic Model- Inception Report
Finally stocks and inventories will be taken as a residual to maintain equilibrium in the
supply and demand sides of GDP.
Where GDPNt is the GDP at current market prices obtained from the supply side.
INT = Interest payments are estimated on the basis of projected profile of domestic and
external public debt and negotiated terms and conditions for interest payments
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Nepal Macroeconomic Model- Inception Report
Merchandise exports and imports of Nepal will be estimated on the basis of gravity
model on international trade:
Exports (XG) of Nepal = f(GDP of Nepal, GDP of major trading partners, total imports
of major trading partners, average shipping cost to major trading partners, export price,
exchange rate of Nepalese rupee in terms of dollar)
Imports (MG) of Nepal = f(GDP of Nepal, GDP of major trading partners, total exports
of major trading partners, average shipping cost from major trading partners, import
price, exchange rate of Nepalese rupee in terms of dollar)
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DISBt and AMORTt are estimated on the basis of projected profile of external public
debt and negotiated terms and conditions for disbursement and repayments of principal.
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Nepal Macroeconomic Model- Inception Report
As mentioned earlier, the major objectives of the ADB TA project are to upgrade the
existing previously developed Nepal Macroeconomic Model (NMEM) and develop a
Dynamic Stochastic General Equilibrium Model (GSGEM) and to improve the capacity
of the concerned stakeholders (especially, NRB, MOF, NPC, CBS and Nepalese
Universities mainly Tribhuvan University) by providing them training on updating the
NMEM and developing using the specified software. Both of these activities need the
specific hardware and software requirements which need to be provided to the
implementing agencies. In this regard, the TA team has intensively explored for selecting
the right one among the available options.
Software Requirement
The software requirement has been explored under two criteria. Firstly, the TA team
needs to select the best econometric software having the capacity of calibrating the pre-
defined econometric models. Secondly, the TA team needs to select the user friendly’s
visual display software having capacity to run simulation exercise (especially policy
shock) in the model without using the econometric software’s command. This second
requirement also includes the selection of appropriate database software in which all the
data required by the model will be stored.
That software - EViews17 (EViews version 6, hereafter will be called only EViews),
which is very user friendly, easy for data transformation/crunching, fast enough for
running several equations, robust for programming and using data from different
platforms, has been selected by the team for achieving the objective of the project be used
through studying the major features of the software – Eviews and comparing mostly used
econometric and statistical Software. Detailed features of Eviews 6 are presented in
Annex-8. Here we summarize the basic features of Eviews 6.
EViews 6 is compatible with most versions of the Windows Operating system including:
Windows 98/Me/NT 4.0/2000/XP/Vista. It can tackle problems involving up to 15
millions of observations or thousands of series. It takes full advantage of 32-bit
Windows’ virtual memory, so that it can work with data sets that exceed system’s
17
Quantitative Micro Software (QMS) has been a leading developer of statistical software for microcomputers for over
two decades. Its first product was the popular MicroTSP software used for model simulation and forecasting. MicroTSP
was replaced by the Windows-based EViews in 1994.
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physical memory, subject to operating system restrictions on the total amount of memory,
up to 3GB with Windows XP and Vista.
Data Handling and Crunching: The NMEM project consists of complex data type
including regular and irregular dated data, cross-section data with observation, and time-
series data. EViews can proficiently handle such complex data structures. It also provides
a wide range of tools for working with data sets (workfiles) including the ability to
combine series by complex match merge criteria and workfile procedures for changing
the structure of data by joining, appending and taking subset, resize, sort, and reshape.
Dynamic Object Updating: EViews incorporates the best of modern spreadsheet and
relational database technology into tools for performing the traditional tasks of statistical
software. The EViews object-based approach includes sophisticated linking technology
that allows defining relationships between multiple objects and external data sources.
Series objects, for example, may be linked by formula to data in other series, to match
merged or frequency converted data from alternate data sets, or to data from external
databases. When defined in this fashion, the linked series dynamically updates its data
whenever the underlying data change. Similarly, an EViews model simulation object can
be linked to equation or system objects so that the model specification updates
automatically when the underlying equation or system is re-specified or re-estimated.
These object updating features are the most useful feature of NMEM project as the model
is expected to be updated very frequently in future.
Import and Export Capacity: EViews can exchange data with other programs very
easily. It can reads and writes over 20 popular data formats including Excel, formatted
and unformatted ASCII/Text, SPSS, SAS (transport), Stata, SPSS, Html, Microsoft
Access, Gauss Dataset, Rats, GiveWin/PC Give, TSP, Aremos, dBase, Lotus, and binary
files. Importing of data to EViews platform is so easy and only drag-and-drop from
foreign file onto can create the EViews workfile. There are dialog and wizards to
customize the importing in easy-to-use way.
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Data Handling Capacity: The number of observations and variables which EViews can
handle is practically unlimited. The physical capacity is specified as following:
Specifications Requirements
Maximum observations per series 4 million (by default), may be increased if
desired, subject to memory restrictions
Total observations: (series x obs per series) limited only by available RAM
Maximum objects per workfile limited only by available RAM
Maximum objects per database limited to 1 million objects, 2 gigabytes or
available disk space
Multiple Window Display: EViews allows for simultaneous display of multiple objects,
each in its own window. This true multiple window support makes it easy to perform
side-by-side comparisons of series plots, hypothesis tests, equation estimates, or model
forecasts developed under alternative assumptions.
EViews allows you to enter individual commands for immediate or batch execution and
allows use of looping and condition branching, as well as subroutine and macro
processing. It also allows matrix primitives, from simple multiplication and inversion, to
more advanced procedures for Kronecker products, eigenvector solution, and singular
value decomposition with the tools for solving complex mathematical problems like
linear and dynamic programming.
Basic Analysis Tools: EViews supports a wide range of basic statistical analyses, from
simple descriptive statistics to parametric and nonparametric hypothesis tests including
testing against specific values, testing for equality between series, or testing for equality
within a single series when classified by other variables. Tools for covariance and factor
analysis allow you to examine the relationships between variables.
Special Tools for Time-Series Analysis: EViews standout among other competitor
software in the tools for sophisticated and diverse tests for time-series data ranging from
simple autocorrelation plots to frequency filters, from Q-statistics to unit root tests in a
very simplified way. It can provide autocorrelation and partial autocorrelation functions,
Q-statistics, and cross-correlation functions, unit root tests (ADF, Phillips-Perron, KPSS,
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Nepal Macroeconomic Model- Inception Report
DFGLS, ERS, or Ng-Perron for single time series and Levin-Lin-Chu, Breitung, Im-
Pesaran-Shin, Fisher, or Hadri for panel data), cointegration tests (Johansen for with
MacKinnon-Haug-Michelis critical values and p-values ordinary data, and Pedroni, Kao,
or Fisher for panel data), causality, and independence tests. EViews computes trends and
circles from time series data using the Hodrick-Prescott filter, Baxter-King, Christiano-
Fitzgerald fixed length and Christiano-Fitzgerald asymmetric full sample band-pass
(frequency) filters.
System Estimation: EViews offers powerful tools for estimating and analyzing both
linear and nonlinear systems of equations by OLS, two-stage least squares, seemingly
unrelated regression, three-stage least squares, GMM, and FIML. The system may
contain cross equation restrictions and in most cases, autoregressive errors of any order.
Forecasting and Simulation for Multiple Equations: EViews can handle multiple
equation forecasting. The EViews can provide the tools for managing, analyzing and
solving large systems of equations. It offers a variety of solution methods, including
stochastic simulation and forward solution for model consistent expectations, as well as
tools for managing alternative solution scenarios and user-specified add factors. It also
allows examining the dependency structure of the endogenous variables and the block
structure of the model equations, to solve simple control problems, and to generate
custom tables and graphs that compare solution results under alternative assumptions.
Diagnostics Tests: Once estimated, EViews makes it easy to perform specification and
diagnostic tests. These tests include Wald tests of linear and nonlinear coefficient
restrictions, likelihood ratio and F-tests for omitted or redundant variables, Lagrange
multiplier tests for serial correlation and ARCH, Breusch-Pagan-Godfrey, Harvey,
Glejser, and White heteroskedasticity tests, Ramsey RESET tests, Quandt-Andrews
breakpoint, and Chow forecast and breakpoint tests.
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EViews can produce high quality graphs and tables for publication or inclusion in other
applications and spool object for the compilation of different outputs.
Graphic Presentation:
EViews supports a wide range of basic graph types including line graphs, bar graphs,
filled area graphs, pie charts, scatter diagrams, mixed line-bar graphs, high-low graphs,
scatter-plots, and box-plots. Any number of graphs can be combined in a single graph for
presentation. There are many easy options for editing the graph from symbols, color,
frame, shading, labeling and scaling including logarithmic scaling and dual scale graphs.
Customizing a graph is as simple as modifying or moving graphic elements on the screen.
Using copy-and-paste or by writing the graph to a Windows metafile, or a PostScript,
bitmap, PNG, GIF, or JPEG file these graphs can be transferred into other applications.
Tables:
Extensive table customization tools allow producing presentation quality tables for
inclusion in other programs. An easy-to-use, interactive interface gives control over cell
font face, size, and color, cell background color and borders, merging, and annotation.
The final outputs can be copy-and-paste to another application or save it as an RTF,
HTML, or text file.
Spooling Facility:
EViews offers a new spool object that allow creating collections of various EViews’
output allowing to store multiple tables, graphs, text, and spools. Various management
tools are allowed to add, delete, extract, resize, annotate, hide and edit the objects in the
spool. This spool is useful for organizing results, for example for creating a log of the
results for a project or an EViews session, or perhaps for gathering output for a
presentation.
After a quick survey of implementing agencies (mainly, NRB, MOF, NPC), the TA team
finds that they have shown their interest to continue with their existing statistical and
econometric software – Eviews, SPSS and STATA. So, the TA team has selected the best
software among these three software. These software have been evaluated on the basis of
those criteria such as: Data Handling, Data Management, Data Updates, Powerful
Statistical Analytical Tools, Equation Estimation and Forecasting, and Model Simulation,
which are mainly required for macro modeling exercise. The results are summarized in
Table 10.1.
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Nepal Macroeconomic Model- Inception Report
Data Updating User Friendly Data Updates though User Friendly Data
Updating system sheet and has risk of Updating system
using combo box omission and using combo box
repetition
Powerful Statistical Good for Cross Good for Cross Good for Time
Analytical Tools Section Data but Section as well as Series Data and uses
time consuming for time series and practical methods
process for Time Panel data, but the generally used in
Series and Panel methods used are government
Data highly technical and departments and
complex, good for central banks.
academic purpose.
Equation Good for Cross Good for Cross Good for Time
Estimation, test, Section Data but Section as well as Series Data and
calibration and time consuming for for time series data practical for
Forecasting Time Series data but the methods professional users in
used are highly the government
complex, academic departments and
and technical. central banks.
(Source: Prepared by TA team on the basis of inputs available on the respective websites
of the concerned software)
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Nepal Macroeconomic Model- Inception Report
It is evidenced from Table-10.1 that the Eviews is the ideal software for macroeconomic
modeling exercises as it uses very powerful statistical techniques for time series data
management and analysis; equation estimation, test and calibration; forecasting of time
series data and model simulation. Regarding other two, SPSS is suitable for cross section
data and simple statistical analysis. STATA is suitable for sophisticated statistical
analysis and testing and is generally used by the academic institutes.
10.4 Recommendation
In the light of above discussion, the TA team will recommend the purchase of the latest
version (i.e. Eviews Version 6) of Eviews software license from its vendor Quantitative
Micro Software (QMS). The TA team advises to purchase the 10 licensing of Eviews
with 2 being stationed with ADB TA Modeling team, 6 being installed at various
departments of the implementing agency (i.e. NRB) dealing with data management, data
analysis and econometric modeling; and the rest (2) being distributed to the associated
implementing agencies, viz. the Ministry of Finance, the National Planning Commission
and other agency, if any. Specifically, Nepal Rastra Bank, being the main implementing
agencies of the TA, should receive the highest number of licenses. As CBS is implanting
another TA on Quarterly Estimates of National Accounts and have separate budget for
hardware and software, the estimated number of software in this report does not take into
account the hardware and software requirements by CBS.
Estimate of Software Cost for the 10 licenses of Eviews with User’s Guide is as follow:
Table 10.2: Cost Estimates Eviews License for 20 Concurrent Use
Details Amount (USD)##
10 Single Seat Use License Pack 12750
Complete Set of Eview’s User Guide (4set*150)# 600
Total 13350
Notes: # One set each set will be provided to Nepal Rastra Bank, Central Bureau of Statistics, National
Planning Commission and ADB- NRM. The other agencies and institution can print the user’s guides
provided in PDF version along with Eviews Installation CD. ## Eviews website available at
http://www.eviews.com reports that the price may subjected to change without prior notice so consider the
price in 10% margin.). (Source: http://www.eviews.com )
The Eviews also provides the facility to purchase Computer Lab Licenses in which a
single license for lab can provide Eviews access to multiple computer of the lab stationed
at one place. However, this option is not feasible for this TA purpose because the
executing agencies of this TA are spread in different places.
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Visual Display Software: A teller based visual display software needs to be designed in
order to make the macro model user friendly to high class policy makers, bureaucrats,
economists and other stakeholders. This software will access the results of macro model
exercise to the user without using Eviews command so that busy high level personal can
also used our model in their various assignment without devoting their valuable time to
learn Eviews command. This software needs to be compatible with operating system of
Windows XP, 2000, Vista and higher. The local software company can provide us this
teller made software at the cost of around USD 2500 to 2800. (Please Note: The estimated
cost is based on the TA member’s experience with similar type of software).
Hardware Requirement: The hardware capacity which can operate the above
mentioned software need to be provided to all implementation agencies. During the visit
to the concern implementing agencies, the TA team finds that the official of
implementing agencies are provided with the computer that can operate the operating
system required by Eviews i.e. Windows XP, 2000, Vista and higher. But, most of these
computers are operated for daily work purpose so these computers have the problem of
hard disk memory and process’s memory so it won’t be compatible to install the licensed
Eviews in such computer as there is high chance of slow operation of Eviews and other
required software. The computer often gets hang when the complex simulation are run in
the Eviews. It has also been observed that the relevant department of Nepal Rastra Bank
that provide the data for modeling exercise are less equipped with the accessories
equipments like printer and photocopy machine. These equipments are required to have
hardcopy of data for its proper review before injecting to model and for inter agencies
communication to revise the model. In this background, the TA team purpose to provide
the following equipments to concern agencies.
Desktop Computer: The desktop computers equal to the number of license of Eviews
need to be provided to all agencies other than ADB- NRM and TA team. So the required
number of the desktop computers will be 14 which will be distributed as per Eviews
license to concern agencies. The minimum required specification for the desktop
computer in order to operate Eviews is as follow:
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Nepal Macroeconomic Model- Inception Report
The cost for the desktop computer depends on its brand. Basically, the most available
brands in Nepal cost between USD 535 to 935. There is so wide deviation between prices
because some brands also provide the licensed operating system whose costs are also
included in the computer’s price.
Laser Print
12 pages per minute (A4 size and letter)
600 X600 dpi resolution
Uses PC memory (Standard 2MB on-board)
USB 2.0 Hi-Speed
A4, B5, A5, LGL,LTR, Executive Envelope
Face down: 100 sheets
220-240 V (+/-10%),50/60Hz (+/-2Hz)
Windows 98/ME/2000/XP, Linux (CUPS)
The cost for the printer depends on its brand. Basically, the most available brands in
Nepal cost between USD 170 to 250.
The tentative budget for the procurement of recommended hardware and software is
provided in Table-10.3. The cost for hardware component is provided in range because
the price of hardware is as per the brand. Further, there might be some changes on the
price without pre notice so the budget should be consider in 10 percent range of price (i.e.
Price might increase or decrease by 10 percent)
Time Table
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Nepal Macroeconomic Model- Inception Report
The TA requests to provide the required software and hardware to the concern agencies
earliest by possible tentatively in the early days of TA’s second phase (i.e. 1 st Week of
January, 2010) so that modeling exercise is smoothly implemented.
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Nepal Macroeconomic Model- Inception Report
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