IMF's Executive Director Commends Nepal's Economic Performance

IMF's Executive Director Commends Nepal's Economic Performance

Feb. 18, 2019, 11:24 a.m.

Executive Directors of IMF commended the authorities on the pick‑up in economic activity in Nepal, supported by greater political stability, more reliable electricity supply, and reconstruction activity. Directors considered that the improved near‑term outlook provides an opportunity to address macroeconomic and financial vulnerabilities and deep‑seated structural weaknesses and boost prospects for long‑term inclusive growth and the attainment of the Sustainable Development Goals.

Directors noted that expansionary fiscal and credit policies are putting pressure on the domestic economy, through higher non‑food inflation and a buildup of financial sector risks, and a wider current account deficit. They recommended a policy tightening in the near term, including through fiscal consolidation , to avoid an abrupt slowdown, and promote a more durable economic expansion.

Directors welcomed the progress made in putting in place a fiscal federalism framework. They noted that public debt remains low and encouraged continued efforts to strengthen tax administration and increase domestic revenue mobilization. Directors observed that more needs to be done to ensure fiscal sustainability, make budgets more realistic and spending more efficient, and build implementation capacity. They agreed that with the devolution of responsibilities and resources to local and provincial levels, efforts should be focused on building policy implementation capacity and instituting a sound public financial management framework at the subnational level.

Directors considered that monetary policy should be tightened, including to support the exchange rate peg to the Indian rupee. They noted that the recently initiated review of the central bank act provides an important opportunity to strengthen the central bank’s operational autonomy and accountability. While Nepal’s external position in FY2017/18 was moderately weaker than that consistent with medium‑term fundamentals and desirable policies, Directors expected that the proposed tightening of policies would help strengthen the external position.

To temper excessive credit growth, Directors encouraged a strengthening of macro‑prudential policies alongside an acceleration of financial sector reforms. They concurred that banks should be encouraged to build additional capital and provisioning buffers against potential losses, and financial sector oversight and regulations should be further strengthened. Directors encouraged the authorities to continue implementing the 2014 FSAP recommendations, and strengthening the AML/CFT regime in line with international best practices.

Directors welcomed the authorities’ efforts to strengthen competition, generate a more conducive environment for investment, and reduce corruption. They called for swift implementation of the structural reform agenda, including revising public procurement laws and easing obstacles to firm entry and operations. Directors emphasized that increasing foreign direct investment, strengthening governance and institutions, and enhancing access to finance, particularly for the undeserved population outside major cities, remain top priorities.

IMF said that Nepal’s economy is enjoying a solid expansion, supported by ongoing reconstruction activity following the 2015 earthquakes and increased growth in manufacturing and tourism-related sectors. Real GDP is estimated to have expanded by 6.3 percent in FY 2017/18 (mid-July 2017 to mid-July 2018), and headline inflation averaged 4.2 percent, held down by subdued food-price inflation.

Government expenditure increased by 32.4 percent (year-on-year) in FY 2017/18, propelled by Nepal’s transition to fiscal federalism and ongoing reconstruction spending. As in previous years, spending was concentrated in the last quarter of the fiscal year. Revenue growth was also substantial (18.9 percent). Nevertheless, the fiscal deficit increased to 6.5 percent of GDP, from 3.1 percent of GDP in FY 2016/17.

On February 8, 2019, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Nepal. The board also said that private sector credit has been expanding very rapidly in recent years, posting 24 percent (y/y) growth in December 2018, following average growth rates above 20 percent since FY 2015/16.

The current account moved sharply into deficit position (8.2 percent of GDP in FY 2017/18), following a modest deficit of 0.4 percent in FY 2016/17. Imports grew by 27.4 percent (y/y), following a 30 percent expansion in FY 2016/17. Exports also expanded, by 15.5 percent, but this growth applied to a low base (exports comprised 3.1 percent of GDP in FY 2017/18). Nepal’s substantial trade deficit is partly financed by buoyant remittance inflows, which grew by 10.2 percent (y/y) in FY 2017/18 and were equivalent to 25.1 percent of Nepal’s GDP. As of December 2018, gross official foreign exchange reserves held by the Nepal Rastra Bank stood at US$ 8.3 billion, having declined by approximately US$1.2 billion from the record set in January 2018.

The near-term outlook for growth is favorable but macroeconomic and financial vulnerabilities continue to build. Growth is expected to reach 6.5 percent in FY2018/19, supported by ongoing reconstruction, investment in hydro-power projects, and strong tourism-related activity. However, fiscal and credit policies are very expansionary leading to rising non-food inflation, a widening current account deficit, falling foreign exchange reserves, and a buildup of financial sector vulnerabilities. Risks are tilted to the downside, related to the financial sector and a possible slowdown in remittances.

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