Press Release No. 12/359

Press Release No. 12/359
September 24, 2012

Mr. Thomas Richardson, 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. Todd Schneider, Deputy Division Chief, Asia and Pacific Department, visited Kathmandu during September 10-24, 2012, to conduct the 2012 Article IV Consultation discussions. The team held wide-ranging discussions with Governor Yuba Raj Khatiwada, Finance Minister Barsha Man Pun, and Finance Secretary Krishna Hari Baskota, other senior officials in the government and the Nepal Rastra Bank (NRB), private sector representatives, 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:

“Macroeconomic performance has been good, but the outlook is challenging. Real GDP growth recovered to 4.6 percent in 2011/12, up from 3.9 percent the previous year. A strong agricultural harvest and robust growth in the services sector compensated for below-trend industrial output. Average headline inflation declined relative to last year, but non-food inflation remained stubbornly high, reflecting the impact of exchange rate depreciation and increases in administered prices for fuels. The balance of payments and external current account recorded sizeable surpluses, as a surge in remittances outstripped the growth of imports. The government fiscal accounts registered a smaller deficit than expected. On the positive side, this reflected improvements in revenue performance and helped to keep public debt on a stable trajectory. But the lower deficit also entailed under-spending on capital projects. Looking ahead, GDP growth is expected to decline, reflecting the effects of the late monsoon, continued weakness in industrial output, and the dampening effects of slowing growth in India. Inflation is likely to remain in the 8-9 percent range, reflecting rising prices in India. The balance of payments surplus is likely to decline as growth of remittances moderates.

“Delays in adopting a full-year budget for 2012/13 could further dampen investment and growth. A full-year budget—limiting the deficit to about 2 percent of GDP, consistent with macroeconomic and debt sustainability—should be adopted as soon as possible. A tighter focus on budget implementation is also needed to ensure appropriately high levels of capital spending to meet Nepal’s pressing infrastructure needs and support medium-term growth. Reaching this goal will be challenging. On the revenue side, further strengthening of tax administration and collection will be vital, as will a focus on collecting arrears. Tighter expenditure management and cash planning will also be key to ensuring that government and donor-supported investment projects are implemented. At the same time, large losses that arose at the Nepal Oil Corporation (NOC) in 2010/11 and Nepal Electricity Authority are unsustainable. Adoption of an automatic price adjustment mechanism that ensures that the NOC avoids future losses is strongly recommended.

“Regarding monetary and exchange rate policy, the exchange rate peg to the Indian rupee should remain the key policy priority. This requires that monetary policy be conducted in a manner that ensures interest rates remain within a certain margin of those in India. In the current environment, excess liquidity generated by strong remittance growth in 2011/12 poses a risk to this objective, and monetary policy should be tightened to absorb this liquidity.

“The influx of remittances in the past year and the associated rise in bank deposits has alleviated some pressures, but risks in the financial sector remain a concern. Weak supervision and a liberal licensing policy in earlier years, combined with more recent excessive exposure to the real estate sector have brought many of these risks to the fore. Welcome steps have been taken to strengthen supervision and expand the framework for taking corrective action at problem banks, while moving ahead with recapitalization of RBB and NBL. Given the remaining risks and the uncertain outlook, however, these efforts need to be accelerated. Key near term steps in this regard include implementation of a revised NRB Act to allow for swift intervention of problem banks, rigorous implementation of the prompt corrective action framework, and strengthened supervision and enforcement of prudential regulations.”