Failure to address FATF suggestions may create financial stress

The Executive Board of the International Monetary Fund (IMF) completed the third review under the four‑year extended credit facility (ECF) for Nepal, allowing the authorities to withdraw the equivalent of $52.25m.  

This brings total disbursements under the ECF for budget support thus far to SDR $222.5m. Nepal has made good progress with the implementation of the program, which has helped mitigate the impact of the pandemic and global shocks on economic activity, protect vulnerable groups, and preserve macroeconomic and financial stability, says IMF in a press statement. 

The program is also helping to catalyze additional financing from Nepal’s development partners. Nepal’s post-pandemic rebound, fueled by a credit boom, ended last year as growth slowed markedly. Low domestic demand helped resolve external pressures but also deflated government revenue and led to a widening of the fiscal deficit despite expenditure control. 

Inflation is declining but remains high at 8.2 percent in September. Growth is expected to recover to 3.5 percent in FY 2023/24, which is below potential, led by increased domestic demand, new hydroelectric capacity, and a continued recovery in tourism. Risks are skewed to the downside. 

External sector risks dominate Nepal’s outlook given its high remittance income and dependence on imported goods. Domestically, further deterioration in bank balance sheets or lack of progress in addressing the deficiencies identified by the Asia Pacific Group of the Financial Action Task Force (FATF) could create financial system stress. 

Bo Li, Deputy Managing Director and Acting Chair, says Nepal has made important strides on its economic reform agenda. Decisive actions in monetary policy, bank regulation and rolling off covid support policies played a major role in overcoming urgent balance of payments pressure in FY 2021/22. He further said : “Reserves continue to rise without the need to use distortive import restrictions. Fiscal discipline was maintained in FY 2022/23 despite a large revenue shortfall.”

Bank supervision and regulation have improved with the rolling out of new supervisory information systems, the Working Capital Loan Guidelines and Asset Classification Regulations. Nepal’s medium-term outlook remains favorable as strategic investments in infrastructure, especially in the energy sector, are expected to support potential growth, he said. 

With growth below potential, boosting the execution of capital spending while maintaining fiscal discipline —growth friendly consolidation—is critical to provide much-needed stimulus to near-term economic growth and achieve investments that will underpin medium-term growth, he says. 

Maintaining momentum on governance reforms is critical to cementing recent gains in fiscal transparency. Further structural reforms, including to mobilize domestic revenue, strengthen public investment management and address fiscal risks, are needed to bolster medium term fiscal sustainability, he added.  “As monetary policy transmission appears weak in a context of balance sheet repair and inflation is elevated —though declining—maintaining the current cautious and data dependent monetary policy is appropriate to preserving price and external stability. 

He further says : “Improving the anti‑money laundering/combating the financing of terrorism (AML/CFT) framework and its effectiveness in line with international standards and peer evaluations is urgently needed to maintain smooth access to the global financial system. 

Reforms to implement the 2021 IMF Safeguards Assessment recommendations regarding the Nepal Rastra Bank (NRB) Act and NRB audit are a priority. “Continued progress on the structural front is also needed to foster investment and more inclusive growth, he says,  “these include improving the business climate, building human capital, and continuing to improve social safety nets, in particular the coverage of the child grant program.”