Press Release No. 15/450

Press Release: Statement by IMF Staff at the Conclusion of the 2015 Article IV Consultation Mission to Nepal

October 1, 2015

An International Monetary Fund (IMF) mission, led by Geert Almekinders, visited Nepal from September 20 to October 1, to hold discussions for the 2015 Article IV consultation. The mission met Minister of Finance Ram Sharan Mahat, Central Bank Governor Chiranjibi Nepal, and other high-level government officials. In addition, the mission met with representatives of the private sector, labor unions, and the donor community.

At the conclusion of the visit, Mr. Almekinders made the following statement:

“The earthquakes in April and May claimed many lives and caused major damage. They also caused economic growth to slow to 3.4 percent in 2014/15, down from 5.5 percent in 2013/14. And losses in agricultural production and damage to transport systems pushed up prices, raising inflation to about 7 percent.

“The mission discussed the macroeconomic policies needed to support Nepal’s recovery from the earthquakes while maintaining macroeconomic and financial stability. Experience in other low-income countries shows that natural disasters can have permanent adverse effects on potential growth. Therefore it is important to adopt ambitious macroeconomic and structural policies. Medium-term prospects for Nepal will be improved if policies are drawn up and implemented to lay the foundation for more robust and sustainable growth while maintaining financial sector stability and medium-term fiscal and debt sustainability.

“Growth is expected to gradually rebound to about 4.4 percent in 2015/16 and around 5.4 percent by 2016/17, as economic activity recovers from the earthquakes and reconstruction gains momentum. Inflation is projected to rise to about 8.5 percent over the next 12 months. However, over time, as agricultural production recovers and transportation infrastructure improves, inflationary pressures should ease. Stepped-up foreign aid and higher inflows of remittances will further boost liquidity pressures in the financial system, necessitating active liquidity management to avoid excess inflation relative to India.

“Recent developments have heightened the downside risks to growth. Continuation of the recent disruptions to economic activity and transportation and trade routes in certain parts of the country could severely affect growth and inflation in this fiscal year. Another important downside risk relates to the government’s capacity to boost capital spending. Owing also to the delays in setting up the National Reconstruction Authority, the increase in expenditure may be more limited than expected.

“Fiscal policy needs to facilitate post-earthquakes reconstruction and medium-term growth through higher public investment. The 2015/16 budget is ambitious and it is opportune that the Budget Speech labeled the current fiscal year as the “Year of Implementation.” Budget execution in Nepal suffers from persistent problems related to structural weaknesses, poor project management and bureaucratic hindrances. The earthquakes have added urgency to the need to improve capital budget execution and the authorities recently announced measures to expedite expenditure and simplify cumbersome approval processes. A coordinated effort by the Ministry of Finance, National Planning Commission, and key line ministries to address bottlenecks is needed.

“Monetary policy should focus on supporting the exchange rate peg and containing inflation. As the economy recovers, the Nepal Rastra Bank (NRB) should aim to keep inflation close to that in India. Bringing down inflation in Nepal is important in its own right but also as a means of ensuring that competitiveness is not lost via the inflation wedge. In light of this, the monetary operations framework needs to be strengthened to put the NRB in a position to better control the growth of broad money. A positive first step in this respect is the introduction of deposit auctions in August 2014. The next step would be to hold regular pre-announced deposit auctions with a view to predictably mop up excess liquidity and systematically raise short-term interest rates from current low levels.

“Last year, Nepal participated in the IMF/World Bank Financial Sector Assessment Program (FSAP). The assessment highlighted a number of weaknesses in the legal and supervisory framework governing financial institutions. The mission welcomes the initiatives taken by the authorities on a number of important fronts to begin to address these weaknesses—which have been amplified by the earthquakes—and to maintain overall financial stability. These efforts should be intensified and complemented by policies to boost inclusive growth through a strengthening of the business climate and concerted efforts to develop Nepal’s vast hydropower potential.

“The mission looks forward to continue discussions with the authorities on policies aimed at improving growth prospects and poverty reduction efforts, while preserving overall macroeconomic stability. A comprehensive package of macroeconomic and structural reforms geared toward boosting public and private investment, social spending and financial inclusion, and strengthening the financial system could form the basis for longer-term engagement with the IMF, possibly through the Extended Credit Facility (ECF).

“I would like to express our sincere appreciation to the Nepalese authorities and our other counterparts for their hospitality and the productive and candid nature of our discussions.”