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Nepal 2017 Article IV Consultation Summary

Core Content

The 2017 Article IV consultation with Nepal, conducted by the International Monetary Fund (IMF), assessed the country's economic recovery following the 2015 earthquakes and trade disruptions at the southern border. The consultation concluded on March 27, 2017, with the Executive Board endorsing the staff appraisal without a formal meeting. The report includes a Press Release, a Staff Report, an Informational Annex, and a Debt Sustainability Analysis.

Main Economic Developments

• Growth and Inflation:

  • Real GDP growth slowed to 0.6% in 2015/16 due to the earthquakes and trade disruptions.
  • Inflation peaked at 12% (y/y) in January 2016 due to shortages of fuel and essential goods but eased to 3.2% (y/y) in January 2017.
  • Growth is projected to reach 5.5% in 2016/17, slightly below the government's target.
  • Inflation is expected to remain above India's in the coming years.

• Fiscal Indicators:

  • Budget under-implementation worsened in 2015/16, but revenues exceeded the budget due to one-off telecom sector collections.
  • Net public debt fell to 22% of GDP, down from 34% in 2011/12.
  • Total revenue and grants increased to 24.2% of GDP in 2016/17.
  • Expenditure rose to 25.3% of GDP in 2016/17, with a projected increase in current spending by 2% of GDP.

• Current Account and Reserves:

  • The current account surplus reached 6.3% of GDP in 2015/16 due to lower imports.
  • Gross reserves of the central bank reached a record US$8.7 billion in January 2017, covering more than nine months of imports.
  • The current account is projected to turn into a deficit in the medium term.

• Private Sector Credit:

  • Private sector credit growth surged to a 7-year high of 31% (y/y) in January 2017.
  • Credit growth was concentrated in overdrafts, which could be diverted to risky activities like real estate and stock purchases.

• Remittances:

  • Workers' remittances, a major source of funding, slowed to 1% in 2015/16 from an annual average of 15% over the previous five years.
  • Remittances are expected to grow more moderately in the medium term.

Key Policy Recommendations

• Fiscal Policy:

  • Focus on facilitating post-earthquake reconstruction and medium-term growth through higher and better-quality public investment.
  • Ensure that increased government spending does not exceed the economy's absorptive capacity and is anchored in a medium-term expenditure framework.
  • Prioritize social spending to support inclusive growth.

• Monetary Policy:

  • Tighten monetary policy to support the exchange rate peg and competitiveness by closing the inflation wedge with India.
  • Strengthen the monetary policy framework by fixing the floor of the interest rate corridor.
  • Continue to implement the interest rate corridor mechanism introduced in mid-2016.

• Financial Sector Reforms:

  • Accelerate reforms in line with FSAP recommendations to mitigate macro-financial risks.
  • Strengthen supervision and governance of the financial sector, particularly given the rapid credit growth.
  • Improve loan classification and provisioning, and upgrade banks' risk management practices.

• Structural Reforms:

  • Enhance policy implementation capacity to overcome chronic under-implementation of the budget.
  • Upgrade transportation infrastructure and improve the business climate.
  • Develop the hydropower sector to unlock growth potential.
  • Create a conducive environment for domestic and foreign investment.

Risks and Outlook

• Risks:

  • Domestic political instability remains a key downside risk.
  • Weak financial sector and liquidity tightening pose significant challenges.
  • Slowing remittances and lower growth in India could impact the economy.
  • Persistent political uncertainty could hinder reform momentum and economic performance.

• Outlook:

  • The medium-term outlook depends heavily on sustaining and deepening reform momentum.
  • In the baseline scenario, growth is expected to settle slightly below the 4% average of the past decade.
  • In the reform scenario, growth is projected to accelerate to nearly 6% in the medium term, supported by increased public capital spending and FDI-financed hydropower projects.

Executive Board Assessment

• The Executive Board endorsed the staff's appraisal, emphasizing the need for stronger policies and sustained reforms to ensure long-term growth and stability.
• The normalization of economic activity is supported by a good monsoon, accommodative monetary policy, and rising government spending.
• The current account is expected to turn into a deficit due to higher imports and slower remittances.
• Political uncertainty and weak implementation capacity are key challenges to achieving the Sustainable Development Goals (SDGs).

Conclusion

The IMF encourages Nepal to continue its reform efforts, improve policy implementation, and strengthen key institutions to support long-term economic growth and stability. A balanced macroeconomic policy mix is necessary to maintain financial stability and support the recovery.