Press Release No. 11/308

Press Release No. 11/308
August 15, 2011

Mr. Sanjaya Panth, Senior Representative of the International Monetary Fund (IMF) to India and Nepal, issued the following statement today in Kathmandu:

“An IMF staff mission led by Mr. John Nelmes, Deputy Division Chief, Asia and Pacific Department, visited Kathmandu during July 31-August 15, 2011, to conduct the 2011 Article IV Consultation discussions. The team held wide-ranging discussions with Deputy Prime Minister Adhikari, Governor Khatiwada, other senior officials in the government and the Nepal Rastra Bank (NRB), private sector representatives, trade unions, and other stakeholders. The dialogue focused on Nepal’s macroeconomic situation and outlook, the financial sector, and policies to address priorities in these areas. The mission’s preliminary findings and recommendations are as follows:

“The macroeconomic context has been challenging. Growth in non-agricultural activity slowed significantly in 2010/11, and despite a good monsoon, overall GDP growth eased to 3½ percent from about 4½ percent the previous two years. Inflation also remained stubbornly high in the range of 9½ percent annually. Despite moderation in import growth, the balance of payments remained under pressure for part of the year from higher international oil prices and slower remittance growth but it ended 2010/11 with a welcome, albeit modest, surplus. Looking ahead, GDP growth is expected to remain below 4 percent in the near term but in the absence of other shocks, inflation should decline somewhat. The balance of payments should show a small surplus, though it will remain vulnerable to the weak global environment.

“The delayed adoption of the 2010/11 budget contributed to the weak economic outturn. The timely presentation of the 2011/12 budget to Parliament is therefore welcome. The authorities’ plans to limit domestic financing of the fiscal deficit to 2 percent of GDP is appropriately consistent with macroeconomic and debt sustainability. However, achieving the deficit target will not be easy. Despite the impressive gains in revenues in recent years, slower economic growth could result in lower receipts than envisaged. At the same time, current spending is budgeted to rise substantially, and additional unbudgeted spending pressures could arise, including for reintegrating former combatants. Taking into account all of the above, the authorities are advised to prepare contingency plans to ensure the domestic financing target is met. These should focus on collection of VAT arrears, further improvements in tax administration, and reductions in unproductive subsidies, while safeguarding spending on priority poverty reduction and infrastructure. At the same time, large losses that arose at the Nepal Oil Corporation (NOC) in 2010/11 are unsustainable. Adoption of an automatic price adjustment mechanism that ensures the NOC avoids future losses is strongly recommended.

“As regards monetary and exchange rate policy, the peg should remain the key policy priority. This requires that monetary policy be conducted in a manner that ensures interest rates in Nepal do not fall below those in India. In the current environment, generalized liquidity injections would be inconsistent with this objective.

“Risks in the financial sector have been building up for some time as financial institutions proliferated in an environment of weak supervision. Excessive exposure of banks and other financial institutions to the real estate sector, where an asset price bubble has now burst, have brought many of these risks to the fore. Well targeted and fully collateralized temporary liquidity support to solvent individual institutions at penalty interest rates is warranted. On the other hand, relaxation of prudential and accounting regulations or blanket provision of liquidity assistance would only postpone addressing the deterioration in financial institutions’ balance sheets, with potentially significant untoward consequences for the economy. The authorities are encouraged to put in place a comprehensive and multi-faceted program of financial sector resolution that includes, among other things, better diagnostic assessments, strengthened supervision and enforcement of prudential regulations, and stronger intervention powers for the NRB.

“In addition to the Article IV consultation discussion, the mission continued the dialogue on a macroeconomic program that could be supported by IMF financial resources. The discussions are ongoing, and an IMF team could return to Kathmandu in the next few months to continue negotiations.”