Growth has rebounded strongly and has reached 7.5 percent (market prices) in FY2017. This is the highest growth rate since 1994, and is a result, in part, of the low growth in the previous year; one of the best monsoons in recent years; increased availability of electricity; and greater investment as the earthquake reconstruction gathered speed, according to the World Bank’s latest Nepal Development Update.
This cyclical rebound follows two challenging years where real GDP growth fell to 3.3 percent in FY2015 due to the devastating earthquake and declined even further to a 14-year low of 0.4 percent in FY2016 due to a complete disruption in cross-border trade with India.
Rice production in FY2017 is estimated to have hit a record high of 5.2 million tons, up from 4.2 million tons a year ago, says the update. About half a million households, eligible to receive housing reconstruction grants, have received the first of three tranches. Second tranche payments have started and are expected to pick up by the end of FY2017. And a series of management reforms has eliminated power cuts in several major cities across Nepal. Meanwhile, more than 100 megawatts of new hydropower capacity, delayed by the earthquakes and the trade disruptions, have come on-stream.
Transport has revived while wholesale and retail trade have normalized, according to the update. Tourism is also recovering, with arrivals reaching pre-crisis levels during the September-December 2016 tourist season. Inflation has decelerated primarily due to the normalization of imports and moderating inflation in India as a result of demonetization.
However, while imports have rebounded, exports remain slow due to sluggish India-bound exports and continued appreciation of the effective exchange rate. As a result, the trade deficit continues to increase. While remittances continue to grow, albeit at a slower pace, external sector pressures are building up.
“Government revenue and spending have performed well,” said Takuya Kamata, the World Bank’s Country Manager for Nepal. “Revenue has exceeded the six months’ target and spending, including on capital goods, has also significantly picked up compared to previous years and is on par with revenue.” Nonetheless, very ambitious expenditures envisioned in the budget have not materialized, leaving previously accumulated government deposits (10 percent of GDP) intact.
Credit grew rapidly over the past year, reaching the highest growth rate since 2012, but deposits growth slowed down. Consequently, banks are running up against prudential limits on lending. Additionally, the government’s large cash balances have had the effect of a monetary tightening at a time when banks are trying to increase their capital base to meet the increased regulatory requirements for paid-up capital.
Looking ahead, the economic growth will remain strong, but it is expected to moderate in line with country’s potential, averaging 5 percent over the next two fiscal years. Inflation will remain below the Central Bank’s target of 7.5 percent in FY2017, but will likely pick up in FY2018 as the effects of the demonetization taper off in India.
However, there are an increasing number of downside risks to this forecast with domestic risks predominating. “Nepal’s growth performance could moderate due to the fluid political environment and transitional challenges that can affect capital spending and uninterrupted service delivery; increased vulnerabilities in the financial sector; continued underperformance of exports; and a risk of a sharper slowdown in remittances,” notes the Update.
“With the increases in government spending as a result of new federal structures and earthquake reconstruction, the fiscal balance is expected to be negative in FY2018,” says Sudyumna Dahal, World Bank Economist and principal author of the Update. “Meanwhile, the current account, which had remained in surplus over the past several years, is expected to narrow and turn into a deficit as import growth is expected persist while growth of exports and remittances is expected to remain sluggish.”
As in previous years, significant underspending of the budget will continue. Post-earthquake reconstruction in sectors other than housing—e.g., cultural heritage, public schools, etc.—remains delayed; banks are running up against regulatory limits for lending and may face additional pressure if the deposit mobilization does not improve; and persistent contraction in migrant departures present a possible sharper slowdown in remittances.