Economic studies
Nepal

Nepal

Population 28.1 million
GDP per capita 1,034 US$
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Synthesis

MAJOR MACRO ECONOMIC INDICATORS

  2017 2018 2019 (e) 2020 (f)
GDP growth (%) 8.2 6.6 7.0 2.5
Inflation (yearly average, %) 4.4 4.1 4.5 6.1
Budget balance * (% GDP) -3.1 -6.6 -4.3 -4.3
Current account balance (% GDP) -0.4 -8.1 -8.3 -10.0
Public debt (% GDP) 26.0 30.2 32.6 34.9

(e): Estimate. (f): Forecast. *Fiscal year 2020 from July 2019 to June 2020.

STRENGTHS

  • Reliable remittance flows sustain consumption, the main driver of growth
  • Expanding services sector, especially tourism
  • Financial and technical support from India and China
  • Recipient of vast sums of international aid
  • Political transformation supports growing stability

WEAKNESSES

  • Landlocked, poor accessibility
  • Natural disasters and extreme climate events, economy still affected by the 2015 earthquakes
  • Infrastructure shortcomings, electricity and fuel shortages, undiversified export basket (clothing and agriculture)
  • Tensions between China and India could make relations difficult
  • Excessive dependence on Indian economy, including a currency peg

RISK ASSESSMENT

Climate instability hits agriculture, but growth remains resilient

In 2020, the reconstruction boom that started after the 2015 earthquake will continue to fade. The slowdown will mostly be caused by a negative supply shock to the agricultural sector (70% of employment and a third of GDP), which is projected to contribute only 1% to growth (down from 1.5%). Summer floods took a heavy toll on rice production and landslides incapacitated existing land supply routes, resulting in depressed yields for 2019 and 2020, and stimulating food inflation from 2-3% in 2018 to 6-7% in end 2019. This will be offset by higher public investment and an acceleration of remittance revenue, upon which the country is highly dependent (27% of GDP). With the removal of migratory restrictions on workers headed for Malaysia, plus a depreciation of the rupee against the USD, remittance flows could bounce back to their 2016 level of 30%. Remittances are the pillar of private consumption, which at 80% of GDP is the cornerstone of aggregate demand and the main driver of growth. The domestic labor market remains riddled by informal employment, with around one third of workers depending on the informal sector. Tourism, of which the potential remains underexploited, is poised to expand with the development of Gautam Buddha International Airport. 2019 legislative measures, including acts promoting public-private partnerships and improving the Special Economic Zone legislation should stimulate foreign investment, which remains low at 1% at GDP. The unexpected slowdown of the Indian economy (which absorbs 50% of exports) has emerged as a risk for export performance.

 

Macrofinancial instability looms among deepening twin deficits

For 2020, the government aims to complete several lingering investment projects (including the Upper Tamakoshi hydroelectric Project), so that public GFCF is expected to rise substantially from 7.5 to 10% of GDP. Moreover, the transition to a federal administration is putting upward pressure on public expenditure, which is projected to shoot up substantially from 28 to 40% of GDP. However, it has become frequent for overly ambitious budgets to be announced and revised downward in mid-year reviews due to improper execution. In fact, local government budgets remain as of yet highly unpredictable as the administrative infrastructure is not fully developed and that understaffing persists. Revenue mobilization will continue to improve but is unlikely to keep up with expenditure, implying a deepening of the deficit.

The current account deficit, which deteriorated sharply in 2018, is expected to widen despite measures to restrict import growth. Nepal is highly dependent on India (65% of imports and 57% of exports) and China. The trade deficit will remain high as Nepalese production lacks diversity and competitiveness. We can also expect a slight increase in the value of remittances, especially coming from Malaysia. At almost 100% of GDP, the level of private credit is abnormally high for a developing country, prompting the use of macroprudential measures. While the combination of a rapidly deepening current-account deficit and excessive domestic credit growth is a classical precursor of macro-financial instability, public debt is low and reserves are sufficient at 8 months of imports.

 

The new government bodes well for political stability

Nepal is undergoing a significant transformation marked by the transition to a federal structure of government. Since the 2017-2018 elections, the Nepal Communist Party (NCP), led by Prime Minister Sharma Oli, holds majorities in both houses. This newfound stability bodes well for the prospect of business-friendly reforms, as evidenced by the creation of the “One Window Service” at the Department of Industry to improve regulatory transparency. Building properly functional sub-national government institutions remains a challenge, as evidenced by systematic budget under-execution. Geopolitically, the country is pursuing gradual realignment towards China and away from India. The country remains a disputed zone of influence between the region’s two giants: it is the third main beneficiary of Indian aid and is also part of the Chinese Belt and Road initiative. However, growing weariness regarding the extent of indebtedness towards China may limit new construction projects. The country continues to face governance weaknesses, including weak rule of law, continued deterioration of freedom of expression, ethnic tensions, high levels of poverty and lingering impacts from the disastrous 2015 earthquake.

 

Last update : February 2020

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