Public Information Notices

Nepal and the IMF





Public Information Notice (PIN) No. 99/12
February 24, 1999
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes Article IV Consultation with Nepal

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On February 8, 1999, the Executive Board concluded the Article IV consultation with Nepal1.

Background

Despite a record of economic growth over the past two decades, Nepal continues to face the challenges of addressing low literacy, widespread poverty, and low life expectancy. With average population growth of about 2 percent, the predominantly rural economy has not grown fast enough to raise living standards significantly.

After the transition to democracy in 1991, the government launched a reform program to promote a modern market-oriented economy, while maintaining sound macroeconomic policies. A number of measures have been taken to liberalize the trade, investment, and financial system to foster private sector development. However, continuing political instability has created a difficult environment for implementing strong reforms. As a result, pervasive weaknesses have impaired fiscal performance, and problems in the banking system persist.

During the period since the last Article IV consultation, the authorities have maintained broad macroeconomic stability and there has been an improvement in the external position. In addition, trade with Nepal’s South Asian neighbors has expanded, following agreements reached with India on trade and transit.

Although there has been little direct impact from the Asian crisis, real GDP growth slowed to below 2 percent in 1997/98 (fiscal year ending July 15), the lowest level in a decade. The decline was broad-based, affecting agriculture, primarily because of poor weather conditions, manufacturing and construction. Other factors were reduced demand in key export markets, delayed development spending, and a decline in private investment due to low business confidence. After remaining in single digits over the last several years, the 12-month inflation rate accelerated to 19 percent as of mid-December 1998, closely following developments in India, and primarily reflecting sharp increases in food prices owing to temporary agricultural supply factors. Non-food inflation has remained at about 4 percent.

External developments have been favorable, with the balance of payments maintaining an overall surplus and with the exchange rate managed prudently. Aided by strong exports in the region and continued generous donor financing, gross official reserves increased in 1997/98 to US$712 million, equivalent to more than 5 months of imports of goods and services. Reflecting the peg to the Indian rupee, the Nepalese rupee depreciated against the U.S. dollar by 16 percent in 1997/98, but the real effective exchange rate has remained broadly unchanged.

Monetary policy accommodated an expansion in private credit and monetary aggregates in 1998. Liquidity in the banking system increased, reflecting a buildup in net foreign assets and a reduction in reserve requirements for commercial banks in March 1998. Interest rates generally declined, with both lending and deposit rates falling by 1-2 percentage points and private sector credit expanded by 16 percent. After falling to a low of percent in October 1998, 91-day treasury bill yields increased to 4 percent in December 1998.

Budget performance has reflected the prevailing weaknesses in overall fiscal policy implementation. The budget outturn in 1997/98 continued to reflect low revenue and development spending, resulting in domestic borrowing in excess of budget targets. A major structural reform was initiated with the introduction of the VAT in November 1997, but the tax has met stiff resistance from the business community. Some progress has also been made in the areas of privatization, expenditure management, and the financial sector. However, the pace of reform continues to be hampered by governance problems and the need to build technical expertise.

The policy discussions focused on removing impediments to faster and broader-based growth including revenue measures to boost public savings, better targeting of government expenditures and improving governance, strengthening agricultural policies, creating new opportunities for the private sector through privatization and reduced subsidies to public enterprises, and ensuring a sound and efficient financial system.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. They commended the authorities for broadly maintaining stable macroeconomic conditions and a relatively liberal trade and investment regime, especially during a period of political changes and uncertainty. Until recent supply disruptions, inflation remained in single digits, and the level of international reserves increased over the past two years. Nevertheless, Directors noted that real GDPgrowth slowed and public savings declined in 1997/98, while inflation had recently accelerated, largely reflecting developments in India and adverse weather and supply conditions. Directors considered that to reduce the still high incidence of poverty, enhance Nepal’s development prospects, and improve the sustainability of the external position, the pace of structural reform should be accelerated.

Directors therefore encouraged the authorities to push ahead with the growth-oriented program of reforms that could eventually be supported by an ESAF arrangement. Welcoming the authorities’ medium-term goal of raising public savings substantially, Directors advised giving high priority to reducing reliance on trade taxation and broadening the tax base through better value-added tax compliance, reduced tax concessions, improved customs valuation procedures, and reinforced tax administration. In particular, it would be critical that the value-added tax be effectively implemented, covering all sectors and avoiding concessions. The fiscal strategy should also include developing a realistic expenditure program for the 1999/2000 budget, strengthening expenditure control, and setting suitable priorities. Directors noted with concern the low priority accorded to expenditures on development and social programs.

Directors recommended that monetary policy be tightened to safeguard the international reserve position and to bring interest rates closer to those in India. Welcoming the conversion into marketable treasury bills of the government’s accumulated overdraft from the central bank, they emphasized that formalizing a limit on new overdraft borrowing would impose greater discipline on fiscal management and increase the Nepal Rastra Bank’s operational independence. Directors agreed that adherence to the exchange rate peg with India would continue to provide a strong anchor for financial discipline, and support further economic integration in the region, especially at a time of some uncertainty in the political environment.

Directors urged the authorities to pursue their medium-term objective of eradicating widespread poverty in Nepal, as well as higher growth in agriculture, hydropower, and tourism, and increased private sector participation in the economy. They also encouraged the authorities to open these sectors to foreign direct investment, as the domestic investment capacity was limited.

Directors considered that priority should be given to structural reforms to accelerate development projects and strengthen fiscal and financial infrastructure and public administration, including the streamlining of the civil service. Directors expressed concern about governance issues, and urged the authorities to enhance the transparency and accountability of public sector activities in order to fight corruption and stop the misuse of public funds.

Noting that financial sector weaknesses needed to be corrected promptly to avoid serious systemic consequences, Directors urged the authorities to move boldly to restructure and eventually privatize Rastriya Banijya Bank and to divest fully the government’s remaining shares in Nepal Bank Limited. Directors commended the central bank’s plans to strengthen the regulatory and supervisory framework, and stressed the importance of providing greater autonomy to the central bank.

Directors encouraged the authorities to strengthen their efforts to improve the macroeconomic database, and disseminate economic statistics on a regular and timely basis.

It is expected that the next Article IV consultation with Nepal will be held on the standard 12-month cycle.


Nepal: Selected Economic Indicators, 1994/95-1997/981

Est.
1994/95 1995/96 1996/97 1997/98

Annual percentage change
Output and prices
Real GDP 3.5 5.3 4.0 1.9
Consumer prices (end-period) 8.7 9.2 1.7 10.1
As percent of GDP
Budgetary operations
Domestic revenue 10.7 10.8 10.5 10.8
Total expenditure 16.0 17.6 16.5 17.9
Regular expenditure 6.9 7.5 7.4 8.1
Development expenditure 9.0 10.0 9.2 9.8
Overall balance 3.5 4.8 3.9 5.0
Annual percentage change
Money and credit end of year
Total domestic credit 25.1 23.5 14.3 13.0
Claims on private sector 39.4 29.2 18.6 16.1
Broad money 16.1 14.4 11.9 17.8
In millions of U.S. dollars2
External sector
Exports, f.o.b.3 660 602 1,113 840
Imports, f.o.b. - 1,275 - 1,350 - 1,778 - 1,559
Current account - 205 - 374 - 218 - 191
(In percent or GDP) - 4.7 - 8.3 - 4.4 - 4.0
Overall balance 1 - 40 59 110
Gross official reserves 702 609 651 712
Rupees per US$ (end-period) 50.5 56.0 57.0 67.9

Sources: Data provided by the Nepalese authorities; and IMF staff estimates.

1Fiscal year ending July 15.
2Unless otherwise indicated.
3Includes re-exports.

1Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.


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