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Nepal Development Update Summary - October 2023

Core Content

This document provides an overview of Nepal's economic developments in Fiscal Year 2023 (FY23), highlighting key trends in the real, external, monetary, and fiscal sectors, as well as the outlook for the next fiscal years (FY24 and FY25). It also includes a special focus on the drivers of external competitiveness and key recommendations for policy improvement.

Main Points

Economic Activity

• Real GDP Growth: Slowed sharply to 1.9% in FY23, the lowest since FY20.
• Sectoral Performance:
  • Agricultural Sector: Resilient, with 2.7% growth due to increased rice paddy production (6.9%) and improved seed varieties.
  • Industrial Sector: Avoided contraction thanks to strong electricity sub-sector growth (+23%), but manufacturing and construction declined by 2% and 2.6%, respectively.
  • Services Sector: Growth slowed to 2.3%, primarily due to the contraction in wholesale and retail trade, though tourism showed double-digit growth.

Investment and Consumption

• Total Investment: Fell by over 10% in FY23, driven by reduced private and public investment.
• Private Consumption: Remained robust at 4.1% growth, supported by strong remittances (+12%).
• Public Consumption: Declined due to reduced fiscal transfers to subnational governments.

Inflation

• Consumer Price Inflation: Reached a seven-year peak at 7.8%, exceeding the central bank's 7% target.
• Drivers:
  • Food Prices: Rose by 6.9%, influenced by supply shocks and domestic policy changes.
  • Non-Food Prices: Increased by 8.5%, mainly due to higher housing, utility, and medical service costs.

External Sector

• Current Account Deficit: Narrowed significantly to 1.3% of GDP, the lowest in six years, due to reduced imports and increased remittances.
• Import Reduction: Caused by domestic import restrictions and India's export controls, with the largest decline in industrial supplies.
• Export Performance: Goods and services exports stagnated, remaining below pre-pandemic levels, with a marginal increase of 0.1% of GDP.

Monetary and Fiscal Policies

• Monetary Policy: Central bank raised interest rates to curb credit growth and stabilize the economy.
• Fiscal Deficit: Nearly doubled to 6.1% of GDP, the highest in over two decades, due to revenue contraction and slower expenditure growth.
• Public Debt: Increased to 41.3% of GDP, driven by fiscal performance issues.

Outlook and Risks

• Growth Forecast: Expected to rebound to 3.9% in FY24 and 5% in FY25, supported by the easing of import restrictions and monetary policy.
• Inflation: Likely to remain elevated, affecting real disposable incomes and private consumption.
• Current Account Deficit: Projected to widen to 3.7% in FY25 and 4.6% in FY25.
• Fiscal Deficit: Expected to decrease to 3.5% in FY24 and 3.3% in FY25 as revenues recover.
• Key Risks:
  • External Shocks: Continued export bans and price fluctuations from India.
  • Domestic Challenges: Lumpy skin disease affecting livestock and erratic monsoons impacting agriculture.
  • Inflationary Pressures: Persistent inflation could lead to further real appreciation of the currency.

Special Focus: External Competitiveness

• Export Decline: Nepal's exports have fallen significantly compared to the early 2000s and peer countries.
• Real Appreciation: Contributed to lower export competitiveness, especially for smaller firms.
• Productivity Gap: Nepal lags behind peer countries and India in productivity across all sectors, affecting its ability to compete globally.
• Recommendations:
  • Macroeconomic Framework: Improve the realism of the budget based on macroeconomic projections.
  • Tax Reform: Shift taxation away from the border and reduce import tariffs.
  • Fiscal Federalism: Strengthen implementation to facilitate effective investment in infrastructure and services.
  • FDI Attraction: Simplify processes to attract more foreign direct investment.
  • Inflation Control: Reduce inflation differential to avoid further real appreciation.

Key Information

• Cutoff Date: September 15, 2023, includes data up to that date.
• Data Sources: National Statistics Office, Nepal Rastra Bank, Department of Customs, and World Bank staff calculations.
• Photo Credit: Sabrina Dangol for the World Bank.
• Cover Design: Print Communication Pvt Ltd.

Conclusion

Nepal's economic performance in FY23 was marked by a slowdown in real GDP growth, driven by monetary tightening and import restrictions. While the external sector improved, inflation remained a challenge. The outlook for FY24 and FY25 is cautiously optimistic, with growth expected to rebound. However, sustaining this growth requires addressing productivity and inflation issues, improving fiscal management, and enhancing external competitiveness.