The World Bank has projected that Nepal's economy is poised to achieve a growth rate of 3.9 percent in the fiscal year 2024. This marks a notable improvement compared to the previous fiscal year, FY 2023, when the country’s economic expansion was limited, registering only a 1.9 percent growth rate.

The World Bank’s optimistic report comes amid a deep economic crisis that the country is facing. Releasing its Nepal Development Update-October 2023 on Tuesday, the World Bank has said that Nepal’s economy is expected to rebound to 3.9 percent in FY 2024 owing to the impact of the lifting of import restrictions, a strong rebound in tourism, and the gradual loosening of monetary policy. The economic growth in FY 2025, will be five percent, according to the World Bank.

In its report, the World Bank says that the impact of lifting the final import restriction measures in January 2023 and the gradual loosening of monetary policy are expected to support growth in the industrial and services sectors. “Sub-sectors that suffered the brunt of the import restrictions and monetary policy tightening in FY 2023, including wholesale and retail trade, construction, and manufacturing, are expected to gradually recover over the forecast period,” reads the report.

While wholesale and retail trade are expected to benefit from the lifting of import restrictions and boost service sector growth, the report says, agricultural sector growth is expected to slow in 2024 due to the impact of the lumpy skin disease on livestock and a decline in rice production.

According to the report, strong energy sector growth helped to avoid an industrial contraction, since manufacturing and construction outputs shrank. Hydroelectric generation increased significantly for the second year in row and added close to 500 megawatts of hydroelectric power to the national grid, the report says, Nepal nevertheless remains a net energy importer.

The top financial body further states that slow credit growth and import restrictions contributed to a reduction in private investment on the demand side. Lower capital expenditure and revenue underperformance drove lower public investment. As a result, total investment decreased by more than 10 percent, a sharper reduction than in 2020. Private consumption remained robust, owing to strong remittance inflows.

Inflation is gradually increasing and a new report says that it is likely to go up.  Average consumer price inflation reached a seven-year peak in 2023. Average inflation amounted to 7.8 percent, above the central bank’s seven percent policy ceiling, driven by both food and non-food prices. Key drivers of food prices, which increased by 6.9 percent, included supply side shocks such as India’s wheat and rice export restrictions, and domestic policy changes including the removal of VAT exemptions on multiple basic food items and price support to producers of rice paddies, milk, and wheat, the report says.

Non-food prices rose by 8.5 percent, driven by higher housing and utility prices, and an increase in the consultation fee of medical doctors in May 2023, the report states, the decline in edible oil prices from February 2023 onwards, reflecting global price reductions, had an offsetting effect on prices. The persistence of high inflation impedes policies to stimulate growth. Particularly, Nepal’s vulnerability to external shocks implies a difficult trade-off between policies that boost growth and those that contain inflation, according to the report.

Agricultural output remained resilient and expanded by 2.7 percent. Rice paddy production supported the sectoral growth and increased by 6.9 percent, reflecting a good summer monsoon and improved seed varieties (Figures 1 and 2). However, a lumpy skin disease has affected livestock as of early April 2023, infecting more than 1m and killing close to 50,000. The resulting lower dairy product and meat production could negatively affect agricultural output growth. Updated statistics will be released by the National Statistics Office in April 2024.

Manufacturing and construction shrank by two percent and 2.6 percent, respectively. The decline was partly due to lower production of key construction materials (cement, basic iron, and steel) and vegetable oils in the first half of FY 2023. Higher frequency indicators suggest that the decline continued in the second half of FY 2023. Lower demand resulting from the elevated prices of manufactured goods and construction materials further weighed on industrial output, which increased by a meager 0.6 percent.

Sluggish wholesale and retail trade slowed the pace of services sector growth. Authorities estimate that the services sector expanded by 2.3 percent in this year, the slowest pace since 2020. Growth of the wholesale and retail trade sub-services sector declined 0.5 percent due to high inflation and lower goods imports.

Looser monetary policy and the lifting of import restrictions imply an increase in goods imports over the medium-term, the report states, policies to contain credit growth and lower one-off imports, including of Covid-19 vaccines, are expected to keep imports below its 2022 historic high. Near-record migration of Nepali workers should be reflected in strong medium-term remittance inflows which, however, are not expected to balance the goods and services trade deficit. Consequently, the current account deficit is expected to widen to 3.7 percent of GDP in 2025, and 4.6 percent of GDP in 2025. 

Revenues are expected to increase in line with higher goods imports, given that taxation focuses heavily on trade. The 2024 budget envisions lower federal spending on capital investment and fiscal transfers to subnational governments, yet higher debt servicing costs. Overall, the recovery of revenues is expected to reduce the fiscal deficit to 3.5 percent in 2024 and 3.3 percent in 2025. Together with the rebound in growth, tighter fiscal policy is expected to keep the overall public debt burden contained at around 41 percent of GDP in 2024 and 2025.

In the external sector, the current account deficit narrowed to a six-year low in 2023, driven by lower imports and higher remittances. The current account deficit fell from 12.6 percent of GDP in 2022 to 1.3 percent of GDP this year.  The reduction occurred through lower imports of goods and services, which fell from 42.6 percent of GDP in 2022 to 34.5 percent of GDP in 2023. Exports on the other hand remained stable, and remittances rebounded strongly. Foreign reserves ended 2023 at a comfortable level of 10 months of concurrent import cover, above the policy floor of 7 months of import cover.

Official remittance inflows surged to a five-year high in this year. Remittance inflows climbed from 20.4 percent of GDP in 2022 to 22.7 percent of GDP.  Nepal’s dependence on the export of workers and remittance inflows increased sharply over the past two decades. Goods and services exports have fallen significantly since the early 2000s as a percentage of GDP.

In FY23, total exports amounted to 6.9 percent of GDP, only one-third of what the average South Asian middle-income country exports. Not surprisingly, the 2019 World Economic Forum Global Competitiveness Index ranked Nepal 108th out of 141 countries.30 Net foreign direct investment (FDI) has also underperformed. Remittance inflows on the other hand increased to 22.7 percent of GDP in FY23, are the main source of foreign currency, and the main driver of private consumption and economic growth.

According to the bank, the near-record migration of Nepali workers should be reflected in strong medium-term remittance inflows which, however, are not expected to balance the goods and services trade deficit. “Consequently, the current account deficit is expected to widen to 3.7 percent of GDP in FY 2024, and 4.6 percent of GDP in FY 2025,” reads the report.

However, there are multiple risks to the outlook including an erratic monsoon, which could dampen agricultural growth; a renewed spike in commodity prices or continued food export bans by India which would raise prices; and higher inflation which could keep policy rates elevated, increase domestic debt servicing costs, and drag on growth. 

“Amid challenges, Nepal is leading the way towards operationalizing its green, resilient, and inclusive development vision to shape the country’s long-term economic recovery,” said Faris Hadad-Zervos, World Bank Country Director for Maldives, Nepal, and Sri Lanka. “Improved external competitiveness is key to driving this recovery and enabling Nepal to compete in export markets, in terms of both prices and quality. This requires an emphasis on reforms to help increase domestic productivity and reduce the inflation differential with Nepal’s trading partners.”

 Major points

• Nepal’s export performance has continuously declined.
• Real appreciation of exchange rate and productivity deficit negatively affected exports.
• The budgetary process needs further strengthening to better support planning.
• Increasing domestic productivity and containing domestic inflation key to improving external competitiveness.
• Credit growth to the private sector slowed owing to policy measures taken to help correct the external imbalances.
• Fiscal space diminished further with the contraction of revenues.
• Economic activity is expected to gradually gain momentum. 
• The current account deficit is expected to increase moderately.
• A rebound in revenues should reduce the fiscal deficit and contain public debt.
• Prudent policies to stimulate growth and contain downside risks are key.

Recommendations

• Changing the current tax model by shifting taxation away from the border and reducing high import tariffs
• Improving the implementation of fiscal federalism which would facilitate effective investments in infrastructure and services
• Simplifying and streamlining processes to attract more FDI which would create significant knowledge and spillover effects.
• In addition, containing domestic inflation would reduce the inflation differential with trading partners. This would help avoid further real appreciation of the exchange rate.