nepal has made

AT A GLANCE

In 2018, the World Bank came up with its Country Partnership Framework (CPF) covering the five-year period of FY2019-2023. Coincidentally, this came at a time of historic transformation in Nepal, as a new government took up office in February 2018. The signing of the Comprehensive Peace Agreement in 2006 ended a 10-year conflict that came at a significant cost of lives and foregone economic development. Since then, Nepal has gone through lengthy and complex transitions towards a new Constitution in năm ngoái that phối in place a federal structure.  By the kết thúc of 2017, elections were successfully held at the federal, state, and local tiers. There is a newfound optimism for greater political stability, inclusion, good governance and sustainable growth. The new federal structure presents unprecedented opportunities for Nepal lớn reset its development storyline, as outlined in the Systematic Country Diagnostic (SCD). 

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At the same time, the shift lớn federalism poses new challenges and source of fragility, given the heightened popular aspirations and expectations. Key challenges include the need lớn clarify the functions and accountabilities of the federal, state, and local governments; deliver basic services and maintain infrastructure development; create a conducive environment for the private sector; and address governance weaknesses that may worsen in the early years of the new federal system.

COUNTRY CONTEXT

In Nepal, the government formed in 2018 was preceded by elections for all three tiers (local, state and federal) of the state architecture defined by the new constitution, marking a protracted but successful conclusion of a political transition that began with the signing of the Comprehensive Peace Agreement in November 2006. State governments largely mirror the coalition at the center. At the sub-national level, funds, functions and functionaries hitherto managed by the central, district and village authorities are moving lớn the seven new states and 753 local governments for which new legislation, institutions and administrative procedures are being formalized as constitutionally prescribed.  Meanwhile, the central level authority is being streamlined with a focus on oversight.  These exercises at state restructuring are expected lớn result in improved outreach and service delivery but will likely take time before they become fully operational. 

Significant adjustments need lớn be made lớn the government structure. They include amending over 400 existing acts, restructuring the civil service at all levels, devolving fiscal management, and determining the division of funds, functions, and functionaries between various levels of government. State restructuring on this scale is uncharted territory for Nepal and smoothening the transition from the previous unitary system lớn the new federal one will remain a daunting task. The new system, in principle, provides opportunities lớn decentralize development benefits and make service delivery more effective and accountable.  However, the risks of jurisdictional overlap between the three tiers of government, lack of clarity and coherence between policies and devolved powers, and duplication of efforts will remain high during the coming few years.  Key aspects of the new system require further definition and may continue lớn be contested by different population groups.

RECENT ECONOMIC DEVELOPMENTS

After the strong rebound in FY22, economic growth slowed in H1FY23 reflecting tighter monetary policy, higher international prices, and the continuation of import restriction measures. Real GDP growth slowed in Q1FY23 despite positive growth in the services and agricultural sectors, as the industrial sector contracted. A decrease in construction activities, the lower registration of new businesses, slower credit growth lớn the private sector, and lower imports of intermediate and capital goods suggest a decline in private investment during H1FY23.

Inflation has been broad-based, with food prices expanding by 7.5 percent y-o-y and non-food price inflation increasing lớn 8.7 percent (y-o-y) in H1FY23. Contributing factors lớn the price increases include higher vegetable prices associated in part with supply shocks in India, cereal grain prices triggered by India’s export ban on wheat and rice, higher transportation prices associated with the increase in global energy prices, and housing and utility prices.

The current tài khoản deficit widened from 7.8 percent of GDP in FY21 lớn a historic high of 12.8 percent of GDP in FY22, associated with a drop in remittances and a larger trade deficit. During H1FY23, a combination of lower goods imports and higher remittances narrowed the current tài khoản deficit lớn 0.5 percent of GDP, the lowest since H1FY17.

The smaller current tài khoản deficit allowed for renewed accumulation of foreign exchange reserves during H1FY23. Foreign exchange reserves climbed lớn USD 10.5 billion in mid-January 2023 from USD 9.5 billion in mid-July 2022. This stock covers 9.4 months of concurrent imports, higher than thở the policy floor of 7 months of imports coverage.

There is no guarantee that imports will not surge again in the future. To avoid a repetition of imposing damaging import restrictions, continued import demand management through interest rate policies and attracting additional sources of external financing will be critical.

Capital adequacy indicators remain above minimum floors, and non-performing loans (NPLs) remain very low by international standards. Total average capital lớn risk-weighted assets ratio – a measure of ngân hàng capital adequacy – ended H1FY23 at 13.1 percent, above the regulatory minimum of 11 percent. At the same time, the NPL ratio ticked up lớn 2.6 percent at the kết thúc of H1FY23. Although financial institution soundness indicators remain reassuring, some forbearance measures in place through the kết thúc of FY23 may be masking actual asset quality in the banking sector.

Monetary policy at the start of FY23 was designed lớn balance tư vấn for the economic recovery with the tightening required for economic and financial stability. The policy rate was increased by 200 basis points (bps) in H2FY22, followed by an additional increase of 150 bps in H1FY23 August 2022. The combined impact of higher international prices, requirements for importers lớn make cash deposits in ngân hàng accounts prior lớn obtaining letters of credit for importation, and policy rate hikes led lớn further slowdowns in credit lớn the private sector during H1FY23. The last remaining import restrictions were lifted in January 2023.

Continued high demand for liquidity was met by the standing liquidity facility in H1FY23 along with the overnight liquidity facility introduced at the beginning of FY23. These windows proved effective at shifting the interbank lending rate lớn within the interest rate corridor beginning in December 2022. Tighter restrictions on credit-to-deposit ratio contributed lớn limiting the credit supply.

Nepal relies heavily on imports as a tax base, which contribute about half of total tax revenues through VAT, excise and import duties. For the first time in five years, Nepal’s fiscal balance was negative in the first half of FY23 at -0.3 percent of GDP as revenues fell across the board while expenditures remained flat. The downturn in revenue growth reflects not only lower imports, but more sluggish economic activity as well. Expenditures, on the other hand, remained broadly stable during a period of electoral activity. The H1FY23 fiscal deficit increased the public debt lớn GDP ratio from 35.6 percent lớn an estimated 38.3 percent between H1FY22 and H1FY23. 

The government’s FY23 Finance Bill incorporated an ambitious tax revenue target of 21.3 percent nominal growth for the year, which a mid-term review adjusted downwards. The mid-year FY23 budget review undertaken by the Ministry of Finance in February 2023 reduced the budgeted revenue estimate downwards from 26 percent of GDP lớn 23 percent of GDP (a 2.9 pp of GDP reduction). The mid-term review cut expenditures by a greater amount, from 28.9 percent of GDP lớn 24.7 percent of GDP (a 4.2 pp of GDP reduction), narrowing the budgeted budget deficit for the year from 5 percent of GDP lớn 3.6 percent of GDP (a 1.3 pp of GDP reduction).

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OUTLOOK, RISKS, AND CHALLENGES 

The high demand for imports witnessed as Nepal emerged from the pandemic has moderated, foreign exchange reserve buffers are accumulating, credit is growing in a more sustainable fashion, tourists are returning lớn the country, and remittances are growing strongly as outmigration surges.

The less positive aspects of the economy’s evolution include lower growth prospects than thở previously anticipated, a fiscal deficit in the first half of the year, and the continuation of a challenging external environment as global interest rates continue lớn rise and commodity prices remain moderately high as Russia’s invasion of Ukraine continues.

The assumptions built into the baseline scenario of this macroeconomic forecast include: (i) a gradual easing of Nepal’s monetary policy repo rate, (ii) declines in global commodity prices in FY24 and FY25 relative lớn FY23; (iii) a gradual increase in international tourist arrivals, reaching pre-pandemic levels by FY25; and (iv) the commitment of the central ngân hàng lớn maintain foreign exchange reserves at a minimum equivalent of 7 months of concurrent imports during FY23-FY25.

The forecast projects growth declining lớn 4.1 percent in FY23 before accelerating once again lớn 4.9 percent growth in FY24 and further lớn 5.5 percent growth by FY25, close lớn the country’s estimated long-term potential growth rate of 5.4 percent. The services sector is expected lớn continue lớn be the primary driver of real GDP growth over the medium term, slowing lớn 5.2 percent in FY23 then averaging 5.8 percent in FY24-FY25. 

Agricultural sector growth is projected lớn average 2.6 percent per year over FY23-FY25 reflecting increased rice paddy production in FY23 and a five-year agreement on the supply of chemical fertilizers between the governments of India and Nepal signed in February 2022. Industrial sector growth is envisioned lớn pick up as newly commissioned hydroelectric power plants drive electricity production higher and boost industrial growth in the medium term.

Average annual inflation is expected lớn rise lớn 6.8 percent in FY23 as the impact of Russia’s invasion of Ukraine keeps commodity prices elevated. Inflation is projected lớn then decline lớn 6 percent in FY24 and 5.5 percent in FY25, reflecting a moderation of global commodity prices and the containment of domestic price pressures through monetary policy. 

Strong remittance inflows, the country becoming a net exporter of electricity beginning in FY23, and moderate growth of imports are projected lớn narrow the current tài khoản deficit from 12.8 percent of GDP in FY22 lớn 2.8 percent of GDP in FY23. While imports are expected lớn rise in the later years of the forecast, their growth is projected lớn be gradual which is reflected in the current tài khoản deficit forecast of 4.2 percent of GDP for FY24 and 3.6 percent of GDP in FY25.

The fiscal deficit is expected lớn remain under 3.5 percent of GDP throughout the forecast, as underspending of the budget continues, and revenues pick up alongside the growth revival beginning in FY24. This forecast includes measures lớn avoid the duplication of spending among the three tiers of governments, the adoption of revenue-enhancing reforms such as the removal of VAT tax exemptions, and improved capital spending with the implementation of new guidelines for the National Project Bank.

Total public debt is projected lớn reach 41.7 percent of GDP in FY23 and then decrease marginally lớn 41.6 percent in FY24 and further lớn 41.5  percent in FY25 as GDP growth outpaces debt accumulation in the outer years of the forecast.

No new shocks are included in the forecast; given the increasing frequency of shocks in recent years, this may be optimistic. Local elections in May 2022 and national and provincial elections in November 2022 were followed by successive changes in administration, the most recent being the collapse of the ruling coalition in March 2023.

Political stability remains important lớn manage the economy and ensure continued pursuit of development priorities. Higher than thở expected inflation would reduce household purchasing power and drag growth. Welfare recovery remains uncertain due lớn rising inflation and risks lớn agricultural production. Reduced investments in human capital, especially amongst those yet lớn recover from a job loss following COVID-19, also impose risks lớn rising inequality.

Last Updated: Apr 04, 2023

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