## 1nplea2019001

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### Recent developments, macroeconomic conditions, and vulnerabilities
- Private sector credit growth: 24 percent (y/y) in December 2018; average growth rates above 20 percent since FY 2015/16.
- Current account: moved to a deficit of 8.2 percent of GDP in FY 2017/18, from a deficit of 0.4 percent in FY 2016/17.
- Imports: grew by 27.4 percent (y/y) in FY 2017/18, following a 30 percent expansion in FY 2016/17.
- Exports: expanded by 15.5 percent (y/y) in FY 2017/18; exports comprised 3.1 percent of GDP in FY 2017/18.
- Workers' remittances: grew by 10.2 percent (y/y) in FY 2017/18 and were equivalent to 25.1 percent of GDP.
- Trade deficit (Table 1): -10,849 (millions of U.S. dollars) in 2017/18; in percent of GDP: -37.7 in 2017/18.
- Gross official foreign exchange reserves: US$ 8.3 billion as of December 2018, having declined by approximately US$1.2 billion from the record set in January 2018; Table 1 reports 9,304 (millions of U.S. dollars) in 2017/18; 8,558 (millions) projected in 2018/19; 6,788 (millions) projected in 2019/20.
- Real GDP: 6.3 percent in 2017/18; projected 6.5 percent in 2018/19.
- Headline CPI (period average): 4.2 percent in 2017/18; projected 4.9 percent in 2018/19; headline inflation presented as 3.7 percent (y/y) elsewhere; non-food inflation reached 6.3 percent (y/y) in December.
- Credit-to-GDP and risks:
  - Expansion of credit over the past 12 months (NR 526 billion) is equivalent to 17 percent of GDP.
  - Sustained private sector credit growth: 21 percent per annum on average over the past four years (narrative).
  - Financial soundness indicators show record-low NPLs alongside high profitability and capitalization, reflecting overdrafts, lax loan classification, and supervisory weaknesses.

### Outlook and risks
- Near-term growth outlook:
  - Growth expected to reach 6.5 percent in FY2018/19, supported by reconstruction, investment in hydro-power projects, and strong tourism-related activity.
  - Economy operating above estimated productive capacity.
- Inflation and deficits:
  - Inflation projected to increase, touching 6.5 percent in FY2019/20.
  - Current account and fiscal deficits projected to remain wide, at 9.6 and 5 percent of GDP, respectively, in FY2018/19.
- Baseline scenario dynamics:
  - Elevated near-term growth will put substantial pressure on the domestic economy and the current account.
  - A substantial fiscal deficit and loose credit policy could lead to rapid reserve declines and force a disruptive adjustment, including abrupt policy tightening from FY2020/21 onward.
- Risks (tilted to the downside):
  - More expansionary fiscal and credit policies could amplify balance of payments pressures and build financial sector risks.
  - Downside growth risks: weak subnational implementation capacity, financial sector vulnerabilities, and slowing remittances affecting liquidity.

### Staff policy scenario and recommended macro path
- Near-term policy stance:
  - Withdraw policy stimulus in the near term to avoid an abrupt slowdown later and lay foundation for sustained medium-term growth.
- Policy actions in staff scenario:
  - Scale back expansion of public spending at the central government level while accommodating post-earthquake reconstruction.
  - Tighten monetary and macro-financial policies to limit domestic demand pressures, contain the CAD, stem reserve declines, and moderate credit growth.
- Expected trade-offs and medium-term gains:
  - Near-term growth more measured, but additional fiscal space and a stronger external balance would enable higher medium-term growth aligned with gradual increases in productive capacity.
  - Swift implementation of structural reforms to ease firm entry and strengthen governance would bolster medium-term outlook.

### Fiscal policy — recent developments, assessment, and recommendations
- Recent fiscal outcomes:
  - General government deficit: 6.5 percent of GDP in FY2017/18 (from 3.1 percent in FY2016/17).
  - Public debt: 30 percent of GDP in 2017/18; public debt trajectory mid-2018 reported at 30 percent of GDP, up from 25 percent in mid-2015.
  - Full implementation of FY2018/19 budget would raise deficit to 8 percent of GDP (staff baseline projects 5 percent of GDP in FY2018/19 aided by revenue measures).
- Staff fiscal recommendations:
  - Front-load fiscal consolidation and improve expenditure composition in the medium term.
  - Policy scenario: lower government expenditure by 0.3 and 1.8 percent of GDP in FY2018/19 and 2019/20, respectively, relative to baseline, to maintain reserves above 5 months of imports.
  - Focus spending cuts on recurring central government elements; reassign key spending responsibilities considering absorptive capacity.
  - Prioritize high-quality infrastructure and post-earthquake reconstruction financed by concessional donor inflows.
  - Strengthen revenue mobilization: finalize and implement draft unified tax code; strengthen tax administration.
  - Complete robust public financial management (PFM) systems at subnational level; adopt Fiscal Responsibility and Budget Management Bill; reinstate realistic medium-term expenditure framework.

### Monetary policy — assessment and recommendations
- Assessment:
  - Peg to the Indian rupee serves as a transparent nominal anchor but current monetary stance is too accommodative.
  - NRB has not mopped up excess liquidity in recent months, causing interbank interest rate volatility and rates generally below the IRC floor (3.5 percent).
  - Interest-rate gap relative to India (example: interbank rate in India is currently 6.5 percent) pressures the pegged regime.
  - Non-food inflation largely determined by domestic factors, implying monetary policy can guide domestic inflation.
- Policy recommendations:
  - Tighten monetary policy stance to rein in imbalances and support the exchange rate peg.
  - NRB should resume using the IRC by actively mopping up excess liquidity and bring interbank rates back towards the mid-point (5 percent).
  - Move IRC higher over time to align short-term nominal interest rates with those in India.
  - Develop a framework for regular reviews of policy stance beyond the annual Monetary Policy Statement; enhance communication on quarterly reviews.
  - In the NRB Act review, prioritize strengthening the central bank’s operational autonomy and accountability.
  - Enhance NRB audit and control environment.

### Credit expansion, macroprudential stance, and financial sector reforms
- Credit boom characteristics and channels:
  - Ongoing sharp credit expansion meets literature criteria for a credit boom; drivers include high remittances, weak oversight, and a 25 percent allocation requirement to priority sectors.
  - Significant bank lending to real estate-related lending, overdrafts, and working capital collateralized by land and real estate.
  - Weak lending and loan classification standards, connected lending, evergreening, and poor risk-management practices persist.
- Reported financial soundness indicators (may mask vulnerabilities):
  - Capital adequacy ratio of Class A banks: 14.6 percent in mid-July 2018 upon completion of capital raising plan.
  - Capital adequacy ratio of state-owned banks: 17.3 percent.
  - Non-performing loans fell to 1.4 percent of total loans.
- Macroprudential and supervisory recommendations:
  - Tighten macro-prudential measures (further tighten LTV ratios, limits on real estate exposure).
  - Adhere to the ceiling on the CCD ratio and phase out carve-outs (including interbank borrowing counting as deposits).
  - Avoid renewal of policies that loosen liquidity (e.g., allowing subnational governments to deposit half of their funds in commercial banks).
  - Consider increasing reserve requirement ratio if loan growth accelerates.
  - Banks should build additional capital and provisioning buffers; issue revised risk management guidelines.
  - Introduce directives to govern revolving lending with clean-up periods to curb evergreening.
  - Empower supervisors to enforce corrective actions; clarify and align lender of last resort policy with standard practices.
- Financial inclusion and directed credit:
  - Nepal lags peers in financial inclusion; staff welcomes Financial Inclusion Action Plan.
  - Gradually phase out directed credit/priority sector lending and replace with price-based support instruments where appropriate.
  - Establish supervisory mechanism for financial cooperatives.

### External sector, reserves, and competitiveness
- External position assessment:
  - Nepal’s external position in FY2017/18 was moderately weaker than consistent with medium-term fundamentals and desirable policies (IMF EBA assessment).
  - FY2017/18 current account: -8.2 percent of GDP (actual); CA norm: -2.5 percent of GDP; CA gap: -5.6 percent of GDP.
  - Correcting for large positive net errors and omissions reduces CA gap to 1.9 percent of GDP and REER overvaluation to 11 percent as of July 2018.
- Reserves:
  - Central bank reserves: record US$9.5 billion in January 2018; fell to US$8.3 billion in December 2018.
  - Traditional metrics: equivalent to about 6 months of prospective imports of goods and services and about 30 percent of broad money (M2).
  - ARA tool for credit-constrained economies: indicates adequate reserves of 2.4 months of current imports.
  - Concern: reserve decline warrants tightening macro policies to prevent falling below 5 months of imports.
- Competitiveness and structural impediments:
  - REER: average REER in FY2017/18 about 14 percent more appreciated than 2010–14 average; revised model indicates REER was 33 percent more appreciated than equilibrium REER from a 126-country panel regression by mid-2018.
  - Competitiveness constraints: infrastructure gap, restrictive labor regulations, past power shortages; FDI at 0.6 percent of GDP in FY2017/18.
- Recommended macro stance:
  - Short-term: tighter fiscal and monetary policies.
  - Medium-term: improve business climate, productivity, and competitiveness to maintain reserve adequacy and support the peg.

### Debt profile, DSA findings, and policy implications
- Public debt definition: includes central government external and domestic debts.
- Public debt levels and composition (mid-2018):
  - Public debt: 30 percent of GDP in mid-2018.
  - External public debt: US$4,781 million (17.4 percent of GDP); PV of external debt: about 13.2 percent of GDP.
  - Creditor composition: Multilateral US$4,297 million (15.7 percent of GDP; 90 percent of external debt); Bilateral US$484 million (1.8 percent of GDP; 10 percent).
  - Domestic public debt: 13.0 percent of GDP (Treasury bills NR 156 billion, Treasury bonds NR 235 billion, development bonds NR 232 billion).
- DSA projections and stress tests:
  - Public debt projected to increase from 30 percent of GDP in mid-2018 to 42 percent of GDP by FY2038/39 under the baseline; PV of total public debt projected to remain below 30 percent of GDP.
  - External debt (nominal) series: 2018: 17.4; 2019: 20.2; 2020: 21.8; 2021: 22.5; 2022: 23.0; 2029: 26.3; 2039: 34.7 (percent of GDP).
  - PV of PPG external debt-to-GDP ratio: 2018: 13.2; 2019: 14.8; 2020: 14.6; 2029: 13.4; 2039: 14.7.
  - External DSA: risk of external debt distress is low; public DSA: risk of public debt distress is low across baseline and stress tests.
  - Key vulnerabilities: growth shocks, exports shocks, and natural disasters; tailored natural disaster shock adds a one-off 10 percentage points of GDP to debt in FY2019/20.
- Policy recommendations:
  - Improve domestic productivity through quality public investment in infrastructure.
  - Strengthen natural disaster prevention and preparedness; build fiscal space and reserve buffers.
  - Tighten monetary and fiscal policy relative to recent expansionary policies.
  - Develop rigorous analysis on contingent liabilities; collect data on PPP and private external debt; compile subnational government debt once fiscal federalism is implemented.

### Structural reforms, governance, and capacity development
- Structural constraints to potential growth:
  - Electricity shortages, transportation infrastructure gaps, political instability, weak governance, and access to finance.
  - Real GDP growth averaged 4.4 percent over the past two decades; potential to improve with power sector and policy stability.
- Reforms and recommendations:
  - Strengthen competition, reduce corruption, revise public procurement laws, and ease obstacles to firm entry and operations.
  - Increase FDI: simplify approval system, clarify foreign investment policies (FITTA amendments), introduce a single window, streamline profit repatriation.
  - Strengthen Investment Board of Nepal Act and amend PPP policy; maintain pipeline of viable PPP projects focusing on transportation and energy.
  - Care with new labor law: avoid reducing labor market flexibility or disproportionate impact on smaller businesses.
  - Rebase national accounts urgently (current base year 2000/01) and improve statistics (national accounts frequency, core inflation series, BOP improvements).
- Capacity development:
  - Fund support requested for fiscal, monetary, legal, and financial statistics areas; need to enhance sub-national fiscal and financial information systems and statistical rebasing.

### Executive Board assessment and authorities’ views
- Directors’ assessment and recommendations:
  - Commended authorities for pick-up in activity supported by political stability, more reliable electricity, and reconstruction.
  - Recommended near-term policy tightening including fiscal consolidation to avoid abrupt slowdown and promote durable expansion.
  - Monetary policy tightening to support the exchange rate peg; strengthen central bank operational autonomy and accountability in NRB Act review.
  - Strengthen macroprudential policies and bank buffers; accelerate FSAP recommendations and AML/CFT strengthening.
  - Prioritize structural reforms to boost FDI, governance, and access to finance.
- Authorities’ views:
  - Authorities were more optimistic on near-term growth and potential growth than staff; emphasized reconstruction-related imports as capital accumulation and expected remittances and external resources to finance trade deficit.
  - Authorities stressed accommodative monetary policy to boost growth while monitoring sectoral credit expansion; noted credit growth needed to support growth and poverty alleviation.

_International Monetary Fund staff report excerpt. Source: NEPAL — STAFF REPORT FOR THE 2018 ARTICLE IV CONSULTATION (PDF chapter/section). January 24, 2019._

### 3.1 percent of GDP in FY 2016/17.

### 1nplea2019001 - 3.1 percent of GDP in FY 2016/17.

### Recent developments, macroeconomic conditions, and vulnerabilities
- Private sector credit growth: 24 percent (y/y) in December 2018; average growth rates above 20 percent since FY 2015/16.
- Current account: moved to a deficit of 8.2 percent of GDP in FY 2017/18, from a deficit of 0.4 percent in FY 2016/17.
- Imports: grew by 27.4 percent (y/y) in FY 2017/18, following a 30 percent expansion in FY 2016/17.
- Exports: expanded by 15.5 percent (y/y) in FY 2017/18; exports comprised 3.1 percent of GDP in FY 2017/18.
- Trade deficit and remittances:
  - Workers' remittances grew by 10.2 percent (y/y) in FY 2017/18 and were equivalent to 25.1 percent of GDP.
  - Trade deficit (in Table 1): -10,849 (millions of U.S. dollars) in 2017/18; in percent of GDP: -37.7 in 2017/18.
- Gross official foreign exchange reserves: US$ 8.3 billion as of December 2018, having declined by approximately US$1.2 billion from the record set in January 2018.
- Inflation and output:
  - Real GDP: 6.3 percent in 2017/18; projected 6.5 percent in 2018/19.
  - Headline CPI (period average): 4.2 percent in 2017/18; projected 4.9 percent in 2018/19.
  - Non-food inflation reached near a 2-year high of 6.3 percent in December (y/y) in the narrative; headline inflation presented as 3.7 percent (y/y) elsewhere in the text.
- Credit-to-GDP and risks:
  - Expansion of credit over the past 12 months (NR 526 billion) is equivalent to 17 percent of GDP.
  - Sustained private sector credit growth: 21 percent per annum on average over the past four years (narrative).
  - Financial soundness indicators show record-low NPLs alongside high profitability and capitalization, reflecting overdrafts, lax loan classification, and supervisory weaknesses.

### Outlook and risks
- Near-term growth outlook: growth expected to reach 6.5 percent in FY2018/19, supported by reconstruction, investment in hydro-power projects, and strong tourism-related activity.
- Risks: tilted to the downside, related to the financial sector and a possible slowdown in remittances.
- External position assessment: Nepal’s external position in FY2017/18 was moderately weaker than consistent with medium-term fundamentals and desirable policies (per IMF EBA assessment in Annex I).
- Reserves adequacy and external metrics:
  - Gross official reserves (Table 1): 9,304 (millions of U.S. dollars) in 2017/18; 8,558 (millions) projected in 2018/19; 6,788 (millions) projected in 2019/20.
  - Reserves in months of prospective GNFS imports: 7.2 months in 2017/18; 5.7 months projected in 2018/19.
  - External debt: 17 percent of GDP (narrative).
  - International Investment Position: positive 10.6 percent of GDP (narrative).

### Fiscal, monetary, and balance-sheet indicators (selected figures from Table 1)
- Output and prices:
  - Real GDP: 0.6 (2015/16), 7.9 (2016/17), 6.3 (2017/18), 6.5 (2018/19 proj.), 6.3 (2019/20 proj.).
  - Headline CPI (period average): 9.9, 4.5, 4.2, 4.9, 6.5 (2015/16–2019/20).
- Fiscal indicators (percent of GDP):
  - Total revenue and grants: 23.3 (2015/16), 24.4 (2016/17), 25.5 (2017/18), 29.2 (2018/19), 29.4 (2019/20).
  - Expenditure: 21.9, 27.5, 32.0, 34.2, 34.4.
  - Net lending/borrowing: 1.4, -3.1, -6.5, -5.0, -5.0.
  - Net incurrence of liabilities: 2.4, 3.2, 6.0, 4.9, 4.9 (foreign: 0.7, 1.3, 2.5, 3.7, 3.9; domestic: 1.7, 1.9, 3.6, 1.2, 1.0).
- Money and credit (annual percent change):
  - Broad money: 19.5, 15.5, 19.4, 14.4, 10.8.
  - Domestic credit: 17.4, 20.2, 26.1, 21.3, 18.1.
  - Private sector credit: 23.2, 18.0, 22.3, 19.8, 16.9.
- Saving and investment (percent of nominal GDP):
  - Gross investment: 33.9, 45.7, 51.8, 55.0, 57.0.
  - Gross fixed investment: 28.7, 31.8, 34.1, 36.2, 37.5.
  - Gross national saving: 40.2, 45.4, 43.6, 45.4, 44.5.
- Balance of payments (millions of U.S. dollars and percent of GDP):
  - Current account (USD mn): 1,339 (2015/16), -93 (2016/17), -2,350 (2017/18), -2,778 (2018/19 proj.), -4,129 (2019/20 proj.).
  - Current account (percent of GDP): 6.3, -0.4, -8.2, -9.6, -12.5.
  - Exports value growth (y/y percent change): -28.8, 9.9, 15.5, 5.3, 8.0.
  - Imports value growth (y/y percent change): -7.4, 30.0, 27.4, 17.9, 16.2.
  - Workers' remittances (USD mn): 6,253, 6,556, 7,224, 8,495, 9,084; in percent of GDP: 29.5, 26.4, 25.1, 29.4, 27.5.
- Public debt and GDP:
  - Public debt (percent of GDP): 27.9, 26.4, 30.4, 33.1, 34.1.
  - GDP at market prices (billions of U.S. dollars): 21.2, 24.9, 28.8, 28.9, 33.0.
- Exchange rate:
  - Exchange rate (NPR/US$; period average): 106.4 (2015/16), 106.2 (2016/17), 104.4 (2017/18).

### Executive Board assessment and policy guidance (Directors' recommendations)
- General assessment:
  - Directors commended the authorities on the pick-up in economic activity supported by greater political stability, more reliable electricity supply, and reconstruction activity.
  - Improved near-term outlook provides an opportunity to address macroeconomic and financial vulnerabilities and structural weaknesses to boost long-term inclusive growth and progress on the Sustainable Development Goals.
- Near-term policy stance:
  - Directors recommended policy tightening in the near term, including fiscal consolidation, to avoid an abrupt slowdown and promote a more durable economic expansion.
- Fiscal policy recommendations:
  - Contain spending pressures, including from fiscal federalism implementation, to keep public debt and the current account on a sustainable path.
  - Rationalize the central government budget as expenditure responsibilities are devolved.
  - For sub-national governments, prepare a medium-term plan aligning spending needs with available funding and build capacity to ensure efficient use of resources.
  - Strengthen tax administration and increase domestic revenue mobilization.
  - Ensure budgets are realistic and spending is more efficient; build implementation capacity at subnational level.
- Monetary policy recommendations:
  - Monetary policy should be tightened, including to support the exchange rate peg to the Indian rupee.
  - The review of the central bank act is an opportunity to strengthen the central bank’s operational autonomy and accountability.
- Financial sector and macroprudential recommendations:
  - Strengthen macro-prudential policies to temper excessive credit growth.
  - Encourage banks to build additional capital and provisioning buffers against potential losses.
  - Strengthen financial sector oversight and regulations.
  - Continue implementing the 2014 FSAP recommendations and strengthen the AML/CFT regime in line with international best practices.
- Structural reforms and governance:
  - Strengthen competition, generate a more conducive environment for investment, and reduce corruption.
  - Swiftly implement structural reform agenda, including revising public procurement laws and easing obstacles to firm entry and operations.
  - Prioritize increasing FDI, strengthening governance and institutions, and enhancing access to finance, particularly for the underserved outside major cities.

*Source: NEPAL — STAFF REPORT FOR THE 2018 ARTICLE IV CONSULTATION (PDF chapter/section). January 24, 2019.*

### 8. The near-term outlook for growth is favorable but inflation, external sector, and

### 8. The near-term outlook for growth is favorable but inflation, external sector, and financial-stability risks are rising.

### Near-term outlook and key projections
- Growth is expected to accelerate somewhat, to 6.5 percent in FY2018/19, well above its historical average.
- Drivers of growth: ongoing reconstruction, investment in hydro-power projects, a rebound in agricultural production, and strong tourism-related activity.
- The economy is currently operating above its estimated productive capacity.
- Inflation is projected to increase, touching 6.5 percent in FY2019/20.
- The current account and fiscal deficits are projected to remain wide, at 9.6 and 5 percent of GDP, respectively, in FY2018/19.
- Conditions driving deficits: strong import growth and a substantial excess of government spending over revenues.

### Baseline scenario, risks, and dynamics
- Under staff’s baseline scenario (reflecting authorities’ established policies):
  - Elevated near-term growth will put substantial pressure on the domestic economy and the current account.
  - A substantial fiscal deficit over the next two years—most notably driven by a large increase in government spending—and loose credit policy in pursuit of the authorities’ ambitious growth targets (8 percent in the FY2018/19 budget) initially contribute to sustained strong growth exceeding potential but worsen external and internal imbalances.
  - Resulting rapid decline in reserves would likely force a disruptive adjustment.
  - In the face of a persistent unsustainable macroeconomic policy mix, declining private financing would be followed by declining official financing, forcing an abrupt policy tightening from FY2020/21 onward to sustain the exchange rate peg, slow the expansion of credit, expose macro-financial risks, and ultimately push down growth in the outer years.
- Risks around the baseline are tilted to the downside:
  - More expansionary fiscal and credit policies than projected could raise near-term growth but would amplify balance of payments pressures, increase pressure on the exchange-rate peg, and build up financial sector risks.
  - Downside risks to growth include subnational governments’ weak implementation capacity, financial sector vulnerabilities, and slowing remittances impacting financial sector liquidity.

### Staff policy scenario and recommended macro path
- Staff recommended withdrawing policy stimulus in the near term to avoid an abrupt slowdown later and lay the foundation for sustained stronger medium-term growth.
- In the policy scenario:
  - Expansion of public spending is scaled back at the central government level while accommodating post-earthquake reconstruction activity.
  - Monetary and macro-financial policies are tightened.
  - These measures would limit domestic demand pressures, contain the CAD, stem the decline in reserves, and moderate credit growth to curb build-up of financial sector risks.
  - Although near-term growth is more measured, additional fiscal space and a stronger external balance of payments would enable higher growth in the medium-term, better aligned with the projected gradual increase in Nepal’s productive capacity.
- The medium-term outlook would be bolstered by swift implementation of structural reforms aimed at easing obstacles to firm entry and operations and strengthening governance and institutions.

### Authorities’ views on outlook and risks
- Authorities were more optimistic than staff on the near-term growth outlook, emphasizing substantial structural changes and forthcoming measures to improve the investment climate.
- They stressed stronger growth is critical to alleviate poverty and achieve the sustainable development goals (SDGs).
- Authorities believed potential growth had risen more rapidly than staff estimated.
- They noted strong import growth and the large CAD were partly driven by imports of construction materials and capital goods that would contribute to capital accumulation, growth and import substitution.
- They highlighted that foreign exchange reserves remained comfortable and expected strong remittance inflows and efforts to mobilize external resources to help finance the large trade deficit.
- Authorities expected balance-of-payments pressures to ease once reconstruction activity slowed and aimed to keep the economy on a high-growth path while containing stability risks.

### Fiscal policy: recent developments, assessment, and recommendations
- Recent developments and assessment:
  - The general government deficit rose to 6.5 percent of GDP in FY2017/18 (from 3.1 percent in FY2016/17), providing a strongly positive impulse of about 3.2 percent of GDP.
  - Public debt ticked up in 2017/18, to 30 percent of GDP.
  - Full implementation of the FY2018/19 budget would raise the deficit to 8 percent of GDP, implying a further fiscal impulse of 1.3 percent of GDP, owing to markedly higher transfers to and revenue sharing with subnational governments and notwithstanding a targeted revenue increase of 5 percent of GDP.
  - Staff’s baseline projection is a fiscal deficit of 5 percent of GDP in FY2018/19, aided by rising imports, rupee depreciation and a wide-ranging tax package; revenues are projected to rise by 29 percent in FY2018/19 in the baseline.
- Policy recommendations:
  - More front-loaded fiscal consolidation and an improved composition of expenditure in the medium-term.
  - The policy scenario advocates lowering government expenditure by 0.3 and 1.8 percent of GDP in FY2018/19 and 2019/20, relative to the baseline, to reduce fiscal deficits and maintain foreign exchange reserve coverage above 5 months of imports.
  - Spending cuts should be focused on recurring elements of the central government budget, considering reassignment of key spending responsibilities to subnational governments.
  - Redistribution of resources across all levels of government should take into account absorptive capacity and preserve fiscal sustainability; over time both financial and human resources will need to shift from the central to subnational governments.
  - Developing implementation capacity at subnational levels is an immediate priority.
  - Infrastructure development should be prioritized, while continuing post-earthquake reconstruction; high-quality capital spending financed by concessional donor inflows should be accommodated.
  - Continue improvements in revenue performance; finalize and implement the draft unified tax code without further delay.
  - Complete process of setting up robust public financial management (PFM) systems at the subnational level, use central e-procurement, adopt a Fiscal Responsibility and Budget Management Bill, reinstate a realistic medium-term expenditure framework.
  - Strengthen PFM in the central government; focus on proper planning, selection, and implementation of major capital projects and spread expenditure more evenly throughout the year.

### Monetary policy: assessment and recommendations
- Assessment:
  - The peg to the Indian rupee continues to serve as a transparent nominal anchor, but the current stance of monetary policy is too accommodative.
  - The NRB has taken no actions to mop up excess liquidity in recent months, leading to substantial interbank interest rate volatility, with rates generally falling considerably beneath the interest rate corridor (IRC) floor (3.5 percent).
  - The persistent interest-rate gap relative to India (where, for example, the interbank rate is currently 6.5 percent) puts pressure on Nepal’s pegged exchange-rate regime.
  - Low and volatile short-term interest rates hamper financial-market development and discourage saving.
  - Staff analysis shows non-food inflation in Nepal is largely determined by domestic factors, suggesting monetary policy can play a role in guiding domestic inflation rates.
- Policy recommendations:
  - Tighten monetary policy stance to rein in imbalances and support the exchange rate peg.
  - NRB should resume using its IRC by actively mopping up excess liquidity when needed, bringing interbank rates back towards the mid-point of the target range (5 percent).
  - The IRC itself should be moved higher over time to better align short-term nominal interest rates in Nepal with those in India.
  - Develop a framework to regularly review the appropriateness of the policy stance, beyond the annual Monetary Policy Statement; enhance communication regarding quarterly reviews conducted by the NRB.
  - In the context of the NRB Act review, amend the Act to strengthen the central bank’s operational autonomy; ensure operational autonomy is the top priority in amending the Act.
  - Staff notes and encourages continued NRB efforts to enhance its audit and control environment.

### Authorities’ views on monetary policy
- Authorities emphasized the need for accommodative monetary policy to boost growth while maintaining financial sector stability.
- They noted the need to closely monitor expansion of credit at the sectoral level to ensure concentration in productive and priority sectors.
- Inflation pressures were assessed by authorities as moderate, allaying concerns about economic overheating.

_International Monetary Fund staff report excerpt._

### 26. The ongoing sharp credit expansion, which meets the criteria commonly used in the

### 1nplea2019001 - 26. The ongoing sharp credit expansion, which meets the criteria commonly used in the

### Credit expansion, channels, and risks
- Ongoing sharp credit expansion meets literature criteria for a credit boom and raises concerns about the quality of lending.
- Drivers:
  - High remittances inflows.
  - Weak financial sector oversight.
  - Requirement to allocate 25 percent of credit to priority sectors (including minimums to agriculture, hydropower and tourism) may affect underwriting standards.
- Lending composition and practices:
  - An important share of bank lending is channeled to real estate related lending, overdrafts, and working capital collateralized by land and real estate.
  - Collateralized lending and mortgages, advance payments, and remittance flows are prominent linkages across real sector, real estate, construction, financial system, and external sector.
  - Weak lending and loan classification standards, connected lending, evergreening, and poor risk-management practices are perceived to persist and may have risen with rapid credit expansion.
- Consequences:
  - Rapid credit growth has fueled a sustained rise in asset prices, which may prompt future corrections.
  - Likely build-up of substantial credit and liquidity risks in the banking system.
  - Recent steps to lower the base rate and relax lending standards regarding margin loans will likely raise risks.

### Financial soundness and supervisory developments
- Reported indicators (potentially masking vulnerabilities):
  - Upon completion of the capital raising plan, capital adequacy ratio of Class A banks amounted to 14.6 percent in mid-July 2018.
  - Capital adequacy ratio of state-owned banks rose to 17.3 percent.
  - Non-performing loans fell to 1.4 percent of total loans amid strong credit growth—very low compared with neighboring countries.
- Authorities’ recent actions:
  - Steps to strengthen regulation and supervision supported by World Bank DPCs and technical assistance from IMF and DfID.
  - Central bank moving toward risk-based banking supervision.
  - Macroprudential measures introduced to curb risky lending.
  - A fourfold increase in minimum paid-up capital was phased in.
  - November 2017 conversion of the Risk Management Guideline to a Directive welcomed; revised risk management guidelines have been drawn up by the NRB with SARTTAC assistance.
- Remaining supervisory weaknesses:
  - Data and supervisory weaknesses persist; supervisors need greater ability to enforce corrective actions.
  - Central bank lender of last resort policy, last updated in 2011, needs clarification and alignment with standard central bank practices.

### Macroprudential stance and specific policy recommendations (financial sector)
- To ensure credit growth slows to a sustainable pace, macro-prudential measures should be tightened:
  - Existing measures (loan-to-value ratios on car loans and residential real estate, and limits on real estate sector exposure) have helped but need further tightening.
  - Staff welcomes authorities’ stated intention to adhere to the ceiling on the loan-to-deposit (LTD) ratio—so-called credit-to-core capital cum deposit (CCD) ratio.
  - Several carve-outs have been introduced over time (including allowing interbank borrowing to count as deposits); these carve-outs should be phased out and authorities should resist further effective relaxation of the CCD ratio and other macroprudential rules.
  - The recent decision to allow subnational governments to deposit half of their funds in commercial banks contributes to an undue loosening of liquidity conditions and should not be renewed.
  - Additional tightening measures such as an increase in reserve requirement ratio can be considered if loan growth accelerates on rising remittances.
- Strengthening oversight and reducing vulnerabilities:
  - Banks should build additional capital and provisioning buffers given data and supervisory weaknesses and the cyclical position of the economy.
  - Issue the revised risk management guidelines to provide structured risk-management expectations (credit, liquidity, operational, market, interest rate risk).
  - Introduce additional policy provisions to control personal and overall overdraft lending.
  - Introduce a directive to govern practices related to revolving lending (including working capital loans), with a requirement for a clean-up period for revolving loans to curb evergreening.
  - Empower supervisors to follow up on inspection findings and rigorously enforce corrective recommendations.
  - Clarify and align lender of last resort policy with standard emergency liquidity assistance practices.

### Financial inclusion and directed credit
- Nepal lags peers in financial inclusion with large gaps between cities and remote districts and between men and women.
- Staff welcomes the recently launched Financial Inclusion Action Plan.
- Policy direction:
  - Gradually move away from mandating credit provision to specific economic sectors.
  - Gradually phase out directed credit and priority sector lending and replace, as appropriate, with price-based support instruments.
  - Establish a supervisory mechanism for financial cooperatives given their number and linkages to banks and role in remote and underserved areas.

### Authorities’ views (financial sector and credit growth)
- Authorities believed credit growth would remain within the limit set by monetary policy and argued strong credit expansion is needed to support growth and alleviate poverty.
- Authorities highlighted the CCD ratio ceiling as controlling excessive credit growth and that risk-based supervision implementation was helping make the financial sector safer.
- Authorities plan reforms to improve the investment climate, including overhauling investment-related laws ahead of the investment summit in March 2019.

### Growth outlook, risks, and staff appraisal
- Near-term outlook:
  - Economic activity picked up considerably; recovery driven by reconstruction and expansionary macroeconomic policies.
  - Growth is expected to rise to 6.5 percent in FY2018/19, well above its potential.
  - Strong domestic demand is pushing up non-food inflation; subdued food inflation is containing headline inflation.
- Risks:
  - Macroeconomic stability risks are rising due to substantial fiscal deficits and expansionary credit policies.
  - Under staff baseline, continued deficits and expansionary credit would put pressure on the domestic economy and current account, likely forcing an abrupt policy tightening and lowering medium-term growth.
  - Risks are tilted to the downside: weak implementation capacity of subnational governments, financial sector vulnerabilities, and slowing remittances impacting liquidity conditions.
- Policy advice to sustain durable growth:
  - Withdraw policy stimulus in the near term.
  - Scale back central government spending and tighten monetary and macroprudential policies to reduce current account pressure and constrain import demand.
  - Swiftly implement structural reforms to raise productive capacity and support more stable and higher future growth.

### Structural reforms, investment climate, and capacity development
- Corruption and governance:
  - Perceptions-based indicators suggest corruption is a significant problem in Nepal relative to South-Asia peers and remains a major obstacle to doing business, behind infrastructure and political stability.
  - Public procurement weaknesses (facilitation payments, favoritism in awarding contracts, lack of proper costing) lead to misappropriation and chronic underinvestment.
  - Recommendations include strengthening the public procurement act (extend the scope of misconduct pursued by the CIAA), impose penalties for improper project assessment, and require well-enforced performance guarantees with penalties for non-performance.
- FDI and investment promotion:
  - FDI comprised 0.6 percent of GDP in FY2017/18, up from 0.3 percent of GDP in FY2015/16.
  - Reduce complexity of approval system; clarify and simplify foreign investment policies (FITTA amendments), introduce a single window, streamline investment approvals and profit repatriation.
  - Strengthen Investment Board of Nepal Act and amend PPP policy to clarify stakeholders’ roles; maintain a pipeline of viable PPP projects focusing on transportation and energy.
  - Care with new labor law: ensure it does not reduce labor market flexibility or disproportionately impact smaller businesses.
  - The investment summit in March 2019 is an opportunity to showcase reform progress and convert pledges into activity.
- Capacity development and statistics:
  - Fund provides significant capacity development support; authorities should match officials to training based on job responsibilities and review NRB staff-rotation policies to retain specialized staff longer.
  - 2018 safeguard monitoring found limited progress; most 2016 recommendations remain outstanding (external/internal audit, financial reporting, NRB autonomy, internal controls).
  - Statistics: national accounts only annual frequency with outdated base year (2000/01); rebasing national accounts is urgent to update GDP composition and address large data discrepancies.

*Source: IMF Staff.*

### 47. The peg to the Indian rupee continues to serve as a transparent nominal anchor and

### The peg to the Indian rupee continues to serve as a transparent nominal anchor and should be supported by a tighter monetary policy stance

### Monetary policy, exchange rate peg, and central bank governance
- The peg to the Indian rupee "continues to serve as a transparent nominal anchor" and "should be supported by a tighter monetary policy stance."
- To tighten policy, reduce interest-rate volatility, and improve the transmission of monetary policy:
  - "the IRC should be upheld and interbank rates should be brought back to its mid-point."
- In the context of the recently-initiated review of the central bank act:
  - "the central bank’s operational autonomy and accountability should be strengthened."
- Staff assessment: "Nepal’s external position in FY2017/18 was moderately weaker than the level consistent with medium-term fundamentals and desirable policy setting."
- The proposed tightening of policies "would help strengthen the external position in the short term."
- "Central bank reserves remain adequate."

### Macroprudential policy and financial sector reforms
- "Macro-prudential measures need to be tightened to temper excessive credit growth and financial sector reforms should to be accelerated."
- Staff welcomes the authorities’ intention "to maintain the 80 percent limit on the CCD ratio," but recommends that "carve-outs to the ratio should be phased out."
- Additional recommendations:
  - Banks should be encouraged "to build additional capital and provisioning buffers against potential losses."
  - "Financial-sector oversight and regulations should be further strengthened."
- Expected outcome: these policies "should help mitigate financial vulnerabilities and contribute to a more sustainable expansion of credit."

### Structural reforms and investment climate
- Staff welcomes authorities’ ongoing efforts "to make Nepal’s economy more competitive, generate a more conducive environment for investment, and reduce corruption."
- Staff encourages "a swift implementation of the authorities’ structural reform agenda aimed at easing obstacles to firm entry and operations."
- Top priorities identified:
  - "Increasing foreign direct investment"
  - "Strengthening governance and institutions"
  - "Enhancing access to finance, particularly for the underserved population outside major cities"

### Article IV consultation timing
- "It is proposed that the next Article IV consultation takes place on the standard 12-month cycle."

*IMF staff summary from the Nepal Article IV consultation excerpt provided in the source content.*

### Box 1. Nepal’s Potential Growth and Comparison to Peers

### Box 1. Nepal’s Potential Growth and Comparison to Peers

### Recent average growth and outlook
- Real GDP growth in Nepal averaged 4.4 percent over the past two decades.
- Recent improvements in the power sector and policy stability bode well for a sustained improvement in the economy’s growth potential in coming years.

### Decomposition of potential growth and comparison with EM Asian peers
- Potential growth decomposition using a standard Cobb-Douglas production function indicates:
  - Weak total factor productivity (TFP) growth relative to a group of Asian EMs.
  - Capital deepening has proceeded relatively slowly.
- Slow TFP growth is compounded by a productivity level well below that of peers, implying substantial room for catchup if appropriate policies are implemented.

### Main recent constraints to potential growth
- Electricity shortages
- Transportation infrastructure gaps
- Political instability
- Weak governance
- Access to finance
- (Reference in source: Nepal: Systematic Country Diagnostic, February 2018. World Bank)

### Role of electricity supply and near-term prospects
- Increases in the quantity, coverage, and reliability of electricity supply should boost productivity.
- Substantial generation capacity is expected to come online in the next two fiscal years, boosted by some large and many smaller hydropower projects.
- Numerous studies highlight positive links between firm productivity and electricity supply and reliability (see e.g., WB Policy Research WP8468).

### Persistent growth acceleration scenarios and IMF staff view
- If growth momentum is sustained, Nepal could join an elite group of countries that have enjoyed ‘persistent growth accelerations.’
- Evidence on persistent growth accelerations:
  - IMFWP18/52 identifies only 95 persistent growth accelerations in a set of 125 countries over the period from 1970-2014.
- IMF staff present comparative projection scenarios for Nepal’s level of GDP relative to persistent acceleration episodes:
  - IMF baseline projection (level of GDP as projected by staff).
  - Optimistic variant: Nepal grows at 6 percent over the medium-term.
  - More optimistic variant: Nepal grows at 8 percent over the medium-term.
- Interpretation of scenarios:
  - If growth follows the IMF baseline path, Nepal would be in the midst of a broadly ‘average’ persistent growth acceleration.
  - Growth at 6 percent places Nepal higher in the distribution of persistent accelerations.
  - Growth at 8 percent would imply an especially strong persistent growth acceleration, in the upper end of the distribution, on par with the experience of China in the early 2000s.
  - IMF staff view the 8 percent scenario as unsustainable and likely to lead to severe economic imbalances in Nepal.

*Source: Box 1. Nepal’s Potential Growth and Comparison to Peers (from the IMF staff report).*

### Annex I. External Sector Assessment

### Annex I. External Sector Assessment

### External position — summary
- Nepal’s external position in 2017/18 was moderately weaker than the level consistent with medium-term fundamentals and desirable policy settings.
- The weakness of the current account and overall balance of payments became more pronounced in the first 5 months of 2018/19.
- Short-term fix: tighter fiscal and monetary policies.
- Medium-term focus: improve business climate, productivity, and competitiveness to maintain reserve adequacy and support the peg to the Indian rupee.

### Net foreign assets and capital structure
- Nepal’s NFA position: US$3 billion (10.6 percent of GDP) as at mid-2018.
- Central bank reserves exceed public external debt; private sector external debt and FDI-related external liabilities are small.
- Drivers of low private external liabilities: government capital-budget implementation bottlenecks and a difficult business climate holding back domestic and foreign private investment.
- Policy implication: continuation of expansionary fiscal policy and improved business climate would likely boost FDI inflows and deteriorate the NFA position toward peers. Currently, Nepal is a net creditor; no immediate sustainability concerns.

### EBA-lite model findings (revised models)
- FY2017/18 current account: -8.2 percent of GDP (actual).
- CA norm (from panel regression): -2.5 percent of GDP.
- CA gap: -5.6 percent of GDP (actual minus norm).
- Assuming trade-balance elasticity to REER of -0.17, closing CA gap implies an REER depreciation of about 32 percent.
- REER developments:
  - Average REER in FY2017/18 was about 14 percent more appreciated than the 2010–14 average.
  - By mid-2018, revised EBA-lite REER model indicates REER was 33 percent more appreciated than the equilibrium REER from a 126-country panel regression.
- Net errors and omissions: 3¾ percent of GDP in FY2017/18 (up from 1¼ percent of GDP average in the two preceding years).
  - Correcting the CA for the large positive errors and omissions reduces:
    - CA gap to 1.9 percent of GDP.
    - REER overvaluation to 11 percent as of July 2018.
- Recent dynamics: REER has depreciated in recent months as the Indian rupee depreciated vis-à-vis the U.S. dollar and inflation remained contained.

### Policy gap and recommended macro stance
- The revised CA model decomposes CA-norm into fundamentals (fitted value) and a policy gap (difference between current and desirable policy levels). Fiscal and monetary policies dominate the policy gap.
- Closing the policy gap would substantially reduce the CA gap and bring REER/external position broadly in line with fundamentals and desirable policies, safeguarding medium-term external sustainability.
- Desirable fiscal stance in the model: cyclically-adjusted fiscal deficit of 2.8 percent of GDP.
  - This is tighter than the FY2017/18 outturn by 2.6 percentage points of GDP.
- Reserve recommendation in the model: grow forex reserves in line with nominal GDP (stable reserves-to-GDP ratio).
  - Actual forex reserves-to-GDP ratio decreased by 2.3 percentage points in July 2018 (y/y), mainly due to expansionary fiscal and monetary policies.

### Competitiveness, capital flows, and structural impediments
- Competitiveness concerns extend beyond REER level: infrastructure gap, restrictive labor regulations, and past power shortages hinder investment.
- FDI: 0.6 percent of GDP in FY2017/18; a key obstacle is the complexity of the current approval system.
- Capital account: remains mostly closed; portfolio flows are zero.
- Recent financing: marked increase in concessional loan disbursements and a large increase in trade credits accompanying the import surge.

### Foreign exchange intervention and reserve adequacy
- Central bank reserves: record US$9.5 billion in January 2018; fell to US$8.3 billion in December 2018.
- Currency composition: about a quarter of reserves held in Indian rupees.
- Traditional metrics and regional comparisons indicate adequacy:
  - Equivalent to about 6 months of prospective imports of goods and services.
  - Equivalent to 30 percent of broad money (M2).
- Risk and precaution:
  - Nepal’s elevated natural-disaster risk and historical experience (reserves always remained above 5 months of prospective imports over past two decades) warrant tightening macro policies to stem rapid reserve decline and prevent falling below 5 months of imports.
- ARA tool for credit-constrained economies with fixed exchange rate regime:
  - Indicates an adequate level of reserves of 2.4 months of current imports of goods and services (considerably lower than current reserve level).
  - Nepal is assessed as “credit constrained” (no regular international capital market borrowing; not “investment grade”).
  - Relevant ARA metric: 0.3*short-term external debt + 0.2*other external debt + 0.05*broad money (M2) + 0.1*exports of goods and services.

### Risk Assessment Matrix — key risks and recommended actions
- Volatile oil prices (External, M, ST/MT, M impact)
  - Main impacts: short-term pressure on CA via higher oil imports; medium-term potential to improve remittance prospects.
  - Policy actions: continue hydroelectric development; tighten fiscal policy stance.
- Rising protectionism and retreat from multilateralism (External, H, ST/MT, L impact)
  - Main impacts: could affect remittance inflows tied to external employment prospects.
  - Policy actions: maintain sound policy frameworks; improve investment climate to reduce remittance dependence.
- Cyber-attacks (External, M, ST, M–H impact)
  - Main impacts: NRB vulnerable due to weak IT infrastructure and practices.
  - Policy actions: strengthen NRB IT capacity as part of broader governance and organizational improvements.
- Excessively expansionary fiscal and monetary policy (Domestic, M, ST/MT, M impact)
  - Main impacts: further BOP pressures, inefficient spending, higher credit growth and financial-sector risks.
  - Policy actions:
    - Closely monitor monthly revenue and expenditure outturns; adjust expenditures downward if needed.
    - Aim for more realistic budgets and a medium-term fiscal plan.
    - Tighten macroprudential policies to contain credit growth.
- Financial sector vulnerabilities exposed by waning remittances (Domestic, M, ST/MT, H impact)
  - Main impacts: slowdown in deposit growth could affect liquidity; soften real estate prices; expose loan-portfolio weaknesses.
  - Policy actions: more forceful exercise of supervisory, corrective, and sanctioning powers; pro-active risk-based supervision.
- Natural disaster (Domestic, L, ST/MT, H impact)
  - Main impacts: high vulnerability to earthquakes and floods.
  - Policy actions: adhere to disaster-proof building codes; build fiscal space and reserve buffers; enhance financial safety nets.

### Revenue-enhancing measures (Domestic Revenue Mobilization Pilot context)
- Recent performance and potential:
  - First five months of the fiscal year: revenue increase by 32 percent (y/y).
  - Central government may be able to raise revenue-to-GDP ratio by 3½ percent of GDP to 26.8 percent of GDP in FY2018/19.
- I. Measures related to tax structure and tax base:
  - Unification of VAT refunds: abolished various additional refunds and exemptions (including VAT rebate on imports of mobile phones, oil and ghee); current system allows standard VAT refunds aligned with international practice.
  - Base-broadening for property tax: land and real estate worth more than NR 1 million now subject to property tax (threshold lowered from NR 3 million).
  - Introduction of health hazard tax on tobacco: 25 paisa per cigarette, bidi and cigar; NR 25 per kilogram on chewing tobacco (import or domestic production).
  - Increased excise duty for vehicles: excise duty on automobiles raised by up to 40 percent depending on engine size.
- II. Measures related to tax administration and enforcement:
  - Reduce under-reporting: import reference prices updated; import documents increasingly matched with export documents from exporting countries; UNCTAD ASYCUDA World rolled out to all main customs offices.
  - Strengthen accounting systems: tax filings increasingly cross-checked against income statements submitted to banks for loan applications.
  - Incentives for tax authorities: performance indicators and rewards linked to revenue targets; zero-tolerance policy for revenue leakage and misappropriation.
  - E-payment system for taxation: a fully-fledged electronic tax payment system is being prepared; currently only large taxpayers are connected.

*Source: IMF staff — Annex I. External Sector Assessment (1nplea2019001).*

### Annex IV. Progress in Implementing High-Priority FSAP

### Annex IV. Progress in Implementing High-Priority FSAP Recommendations

### Financial Stability Oversight
- Recommendation: Refocus monetary policy operations on domestic liquidity management to reduce excess reserves, and especially their volatility, with appropriate burden sharing of costs between the financial system and the budget. Introduce Treasury sterilization bonds.
  - Responsible Authority: NRB
  - Time Line: Short term (ST)
  - Progress: Not done
  - Progress to date: An interest rate corridor (IRC) was operated during FY2017/18, leading to the stabilization of short-term interest rate. However, since July 2018 monetary operations have become largely accommodative again.
- Recommendation: Undertake a thorough Asset Quality Review (AQR) to identify the extent of problem loans in banks’ balance sheets (with TA support).
  - Responsible Authority: NRB
  - Time Line: ST
  - Progress: Fully Implemented
  - Progress to date: A Special Inspection Program (SIP) to review asset quality was conducted in 2015.
- Recommendation: Conduct an in-depth review and financial analysis of loan portfolios during bank examinations.
  - Responsible Authority: NRB
  - Time Line: ST/Medium term (MT)
  - Progress: In process
  - Progress to date: Loan portfolio reviews are performed on a regular basis during on-site inspections. The reviews increasingly focus on asset quality and borrowers’ financials.
- Recommendation: Reinforce efforts to address financial infrastructure shortcomings in the Payments System, clearing, credit information, collateral registry, and debt recovery areas.
  - Responsible Authority: NRB/MOF
  - Time Line: ST/MT
  - Progress: In process
  - Progress to date:
    - A Payment and Settlement System Department was established in 2015. Directives for Payment Institutions and Licensing Policy for Payment-Related Institutions were issued in 2016. Nepal Payment System Development Strategy was issued, and Payment System Oversight Framework of 2018 was published. A real-time gross settlement system is expected to be operational in September 2019.
    - The Payment and Settlement Act is before parliament. Payment System Oversight Bylaws are under discussion.
    - Nepal Financial Reporting Standards (NFRS) were adopted by Class A banks in FY2016/17.
    - Limited progress has been made regarding the strengthening of the credit information bureau, the collateral registry and debt recovery areas.

### Financial Sector Oversight — A. Banking Sector
- Recommendation: Redefine supervisory approach by: integrating risk-based off-site and on-site supervision; increasing analytical capacity through training; introducing supervisory management information systems (MIS); developing a dedicated human resources (HR) rotation policy; and streamlining the NRB board participation in operational decisions.
  - Responsible Authority: NRB
  - Time Line: ST/MT
  - Progress: In Process
  - Progress to date:
    - Risk-based on-site supervision is being implemented for Class A banks.
    - SARTTAC TA has been received to help extend it to off-site supervision, following the installation of the Supervisory Information System (SIS) planned for August 2019.
    - Regular training is being provided for on-site and off-site supervisors, and unit-wise rotation policy is being implemented.
    - No action taken on streamlining the NRB Board’s participation in operational decisions.
- Recommendation: Ensure effective compliance with supervisory directives and guidelines by: performing a thorough follow up of the implementation of supervisory recommendations; proactive, earlier, and stronger corrective actions.
  - Responsible Authority: NRB
  - Time Line: MT
  - Progress: In Process
  - Progress to date: The onsite inspection and enforcement unit in the Banking Supervision Department continue to follow up on the implementation of supervisory recommendations. Risk Management Directive was issued in November 2017, in order to strengthen the effective enforcement of major components of Risk Management Guidelines.
- Recommendation: Review licensing regulations and policy to strengthen the licensing process and support a consolidation of the sector. Once completed, re-license all Classes A, B, and C banks that meet the new reinforced requirements, with an appropriate phase-in period, into a single-license category.
  - Responsible Authority: NRB
  - Time Line: MT
  - Progress: Not done
- Recommendation: Granting the NRB explicit consolidated supervision powers, amending the legal framework to incorporate a comprehensive definition of related parties and controlling interests.
  - Responsible Authority: NRB
  - Time Line: MT
  - Progress: Not done
  - Progress to date: The Bank and Financial Institutions Act (BAFIA) 2016 defined the terms "Related Party" and "Controlling Interest". But the NRB has not been granted consolidated supervision powers in the amended NRB Act and BAFIA.

### Financial Sector Oversight — B. Non-banking Sector
- Recommendation: Divide the CIT into two separate legal entities, segregating the capital market business, to be placed under the supervision of the Securities Board of Nepal (SEBON), from the pension fund business.
  - Responsible Authority: MOF/SEBON
  - Time Line: ST
  - Progress: Not done
- Recommendation: Place the EPF and CIT pension fund business under the joint supervision of the Insurance Board (IB) and NRB.
  - Responsible Authority: IB/NRB/MOF
  - Time Line: MT
  - Progress: Not done
- Recommendation: Strengthen the operational independence of the IB and SEBON.
  - Responsible Authority: SEBON/IB/MOF
  - Time Line: ST
  - Progress: Not done
  - Progress to date: For now, the focus is on strengthening the capacity of the IB and the SEBON.

### Crisis Management
- Recommendation: Revise Prompt Corrective Action (PCA) policy to require stronger supervisory action, including designation of problematic status at an earlier stage of capital depletion.
  - Responsible Authority: NRB
  - Time Line: ST
  - Progress: Fully implemented
  - Progress to date: The revision was completed (PCA Bylaws 2074 (2016/17))
- Recommendation: Develop and implement a banking financial institution (BFI) Supervision Enforcement policy that presumes certain enforcement action based on CAMELS ratings.
  - Responsible Authority: NRB
  - Time Line: MT
  - Progress: In process
  - Progress to date: The supervisory adjustments in risk weighted assets are currently tied up with CAMELS ratings.
- Recommendation: Revise NRB Act to clarify emergency liquidity assistance (ELA) provisions.
  - Responsible Authority: NRB/MOF
  - Time Line: ST
  - Progress: In process
  - Progress to date: The NRB Act Amendment extended the tenure for refinancing and lender of last resort facilities from 6 months to 1 year. The ELA framework is under consideration with expected completion by end-FY18/19.
- Recommendation: Revise NRB Act to grant it special resolution regime powers.
  - Responsible Authority: NRB/MOF
  - Time Line: ST
  - Progress: Fully implemented
  - Progress to date: A separate section (Chapter 9A) has been added to the NRB Act, which provides special resolution regime powers to the NRB. It includes sections which provide power to liquidate an institution, appoint a Special Administration Group, establish Bridge Institution/Unit, etc.
- Recommendation: Establish a national financial crisis coordinating committee comprised of all financial sector, regulatory, and supervisory agencies. Develop each individual agency’s crisis contingency plans and roll up individual agency plans into a national crisis contingency plan.
  - Responsible Authority: MOF/NRB/IB/SEBON
  - Time Line: ST/MT
  - Progress: In process
  - Progress to date: A high-level Financial Sector Coordination Committee is in place. Chaired by the Finance Minister, and comprising NRB, SEBON, and IB representatives, it coordinates financial sector issues and policy changes. Crisis contingency plans still need to be developed.
- Recommendation: Crisis simulations should be conducted periodically.
  - Responsible Authority: MOF/NRB/IB/SEBON
  - Time Line: MT
  - Progress: Not done

### Fund Relations and Statistical Issues (selected items)
- IMF membership and accounts:
  - Joined September 6, 1961; accepted Article VIII, Sections 2, 3, and 4 on May 30, 1994.
  - Quota: 156.90 SDR Million (100.00 percent)
  - Fund holdings of currency: 140.92 SDR Million (89.82 percent)
  - Reserve position in Fund: 15.98 SDR Million (10.19 percent)
- SDR Department:
  - Net cumulative allocation: 68.10 SDR Million (100.00 percent)
  - Holdings: 4.81 SDR Million (7.06 percent)
- Outstanding Purchases and Loans:
  - RCF Loans: 47.06 SDR Million (29.99 percent)
- Projected Obligations to Fund (in millions of SDRs; based on existing use of resources and present holdings of SDRs):
  - Forthcoming Principal and Charges/interest totals:
    - 2018: Principal 2.85; Total 2.85
    - 2019: Principal 5.70; Charges/interest 0.68; Total 6.39
    - 2020: Principal 2.85; Charges/interest 0.69; Total 3.54
    - 2021: Principal 7.13; Charges/interest 0.68; Total 7.81
    - 2022: Principal 7.13; Charges/interest 0.68; Total 7.81
- Exchange rate arrangement:
  - Nepalese rupee is pegged to the Indian rupee at a rate of NRs 1.6 per Indian rupee.
  - As of December 21, 2018, the exchange rate was US$1=Nrs. 111.53.
- Safeguards assessments:
  - An update safeguards assessment of the NRB was completed in February 2016; it found limited progress and emphasized need for an auditor with requisite experience and legal framework enhancements.
  - A safeguards monitoring mission in May 2018 found limited progress and noted the NRB’s autonomy was further weakened by subsequent amendments to the NRB Act.
- Technical Assistance (since 2017 Article IV Consultation) — Purpose and Year (selected):
  - MCM Strengthening Internal Audit 2018
  - Cyber Security 2018
  - SARTTAC Financial Soundness Indicators 2017
  - Liquidity Forecasting and Management 2017
  - Financial Supervision and Regulation 2017
  - Strengthening Fiscal Reporting 2018
  - Budget Formulation and Good Practices 2018
  - Government Finance Statistics and Public Sector Debt Statistics Training 2018
  - Price Statistics Training 2018
- Statistical capacity and data issues:
  - National accounts compiled using 1993 SNA; plans to rebase from 2000/01 to 2010/11 during 2019.
  - CPI: new series with 2014/15 base released in October 2015; core inflation series is not published.
  - WPI: weights based on 1999/2000 data; covers agricultural commodities (49.6 percent), domestic manufactured goods (20.4 percent), and imported goods (30 percent).
  - Government Finance Statistics: implementation of GFSM 2001 begun in 2011; TSA rolled out to all 75 districts including Kathmandu.
  - Monetary and Financial Statistics: NRB reports SRFs 1SR, 2SR, and 5SR monthly with a lag of about one month; expanded broad money survey now compiled and published.
  - Financial Soundness Indicators: NRB reports 12 core FSIs and 8 of the 13 encouraged FSIs for deposit takers on a quarterly basis with a lag of about 4 months.
  - External Sector Statistics: BOP compiled in BPM5 with shortcomings (underestimation of imports; problems measuring remittances; incompleteness of foreign grants data; absence of direct investment data; unrecorded financial flows). NRB started reporting IIP data in February 2015 following BPM6. IMF STA TA has supported improvements since 2012.
- Data standards:
  - Nepal has implemented the recommendations of enhanced General Data Dissemination System (e-GDDS). National Summary Data Page launched in June 2017.
- Table of Common Indicators Required for Surveillance (as of December 31, 2018) — Date of latest observation examples:
  - Exchange Rates: 12/18
  - International Reserve Assets and Reserve Liabilities: 11/18
  - Reserve/Base Money: 11/18
  - Broad Money: 11/18
  - Consumer Price Index: 10/18
  - GDP/GNP: 2017/18
  - International Investment Position: Q2/18

*Source: Annex IV. Progress in Implementing High-Priority FSAP Recommendations; Staff Report for the 2018 Article IV Consultation — informational annex (January 24, 2019).*

### 1.      Public debt in this analysis includes the central government’s external and domestic debts.

### 1nplea2019001 - 1.      Public debt in this analysis includes the central government’s external and domestic debts.

### Background on debt
- Definition: Public debt in this analysis includes the central government’s external and domestic debts.
- Coverage and contingent liabilities:
  - As of mid-July 2018, Nepal’s state and local governments had no debt and the government has not provided any guarantees for debts of state-owned enterprises (SOEs).
  - SOE debt: Nepal’s SOEs had no debt except for funds on-lent to them by the central government (4 percent of GDP in July 2018), which is already included in central government debt.
  - The Nepal Rastra Bank (NRB) borrowed from the IMF through the Rapid Credit Facility and on-lent the funds (about US$50 million) to the government.
- Public debt trajectory:
  - Public debt rose to 30 percent of GDP by mid-2018, up from 25 percent of GDP in mid-2015.
  - Mid-2018 public debt ratio exceeded the previous DSA projection of 23 percent of GDP.
  - NRB deposits remain substantial: NR 126 billion in mid-2018, equivalent to 4.2 percent of GDP.

### Composition of public debt (mid-2018)
- External public debt:
  - Total external public debt: US$4,781 million (17.4 percent of GDP).
  - Net present value (PV) of external debt: about 13.2 percent of GDP (high concessionality).
  - Creditor composition:
    - Multilateral: US$4,297 million (15.7 percent of GDP; 90 percent of external debt)
      - AsDB: US$1,960 million (7.1 percent of GDP; 41 percent of external debt)
      - IDA: US$2,160 million (7.9 percent of GDP; 45 percent of external debt)
    - Bilateral: US$484 million (1.8 percent of GDP; 10 percent of external debt)
      - Paris Club: US$277 million (1.0 percent of GDP; 6 percent of external debt)
      - non-Paris Club: US$207 million (0.8 percent of GDP; 4 percent of external debt)
  - Average terms: interest about 1 percent and average maturity about 26 years for multilateral loans.
  - Largest bilateral creditor: Japan, followed by China, Korea and India.
- Domestic public debt:
  - Total domestic debt: 13.0 percent of GDP.
  - Composition:
    - Treasury bills: NR 156 billion (5.2 percent of GDP; 40 percent of domestic debt) — 91-day, 182-day, 364-day bills.
    - Treasury bonds: NR 235 billion (7.8 percent of GDP; 60 percent of domestic debt).
    - Development bonds (subset): NR 232 billion (7.7 percent of GDP; 59 percent of domestic debt) with maturities of 3–15 years and interest rates of 3–6.5 percent per annum.
    - Others: 0.1 percent of GDP (1 percent of domestic debt).

### Contingent liabilities and PPPs
- No official data available on signed PPP contracts and private external debt for this analysis.
- Default magnitude for contingent liability stress test used: 6.8 percent of GDP, broken down as:
  - PPP projects: 1.8 percent of GDP (calculation: 1.8 percent of GDP = 5.3 percent of GDP * 35 percent of shock).
  - Financial market: 5 percent of GDP (default minimum value).
- Notable SOE debts:
  - Nepal Oil Corporation (NOC) and Nepal Electricity Authority (NEA): as of July-2018 their debt amounted to about 4 percent of GDP; their debts are owed to the government.
- Pension liabilities: civil service pension liabilities are not included in the debt stock; they remain modest and projected to remain stable under the present public pension scheme.

### Macroeconomic forecasts and assumptions
- Growth and inflation:
  - Real growth: 7.9 percent in 2016/17; 6.3 percent in FY2017/18.
  - Staff baseline: 6.5 percent in FY2018/19 and 6.3 percent in FY2019/20; medium-term average about 5 percent.
  - Inflation (CPI period average): 4.2–4.5 percent in FY2016/17 and FY2017/18; expected to rise to 4.9 percent in FY2018/19 and 6.5 percent in FY2019/20 (text contains exact series).
- External sector:
  - Current account: large deficit in FY2017/18 of 8.2 percent of GDP despite remittances of 25 percent of GDP in FY2017/18.
  - Remittances: 25 percent of GDP in FY2017/18.
  - External debt projections: projected to increase to around 23 percent of GDP by 2020/21 and around 33 percent of GDP by 2038/39.
  - Large positive net errors and omissions: 3.8 percent of GDP in FY2017/18.
- Fiscal:
  - Overall fiscal deficit widened to 6.5 percent of GDP in FY2017/18.
  - Primary deficit projected: 4.3 percent of GDP in FY2018/19; average 1.4 percent of GDP over the medium term.
  - Net acquisition of non-financial assets and other fiscal series are presented in the source text (Text Table 1).

### Debt projections and realism of the baseline
- Public debt projection:
  - Public debt projected to increase from 30 percent of GDP in mid-2018 to 42 percent of GDP in FY2038/39 under the baseline, remaining below the 70 percent benchmark.
  - PV of total public debt projected to remain stable below 30 percent of GDP over the projection period.
- Domestic debt path:
  - Public domestic debt projected to decrease to 10 percent of GDP over the medium term and to 7 percent of GDP in the long term.
- Realism assessment:
  - The baseline fiscal adjustment of 4.5 percentage points in 3 years is in the upper quartile of historical adjustments but considered plausible given Nepal’s track record (10-year average primary surplus-to-GDP ratio of 0.6 percent for 2007–2016).
  - Baseline assumes enhanced growth effects from completion of large hydropower projects (e.g., Upper Tamakoshi).

### Country classification and stress tests
- Debt carrying capacity:
  - Composite indicator (CI) computed as 3.24, placing Nepal in the “strong” rating.
  - The CI uses weighted averages of CPIA, real GDP growth, remittances, foreign exchange reserves, and world growth based on 10-year averages.
- Stress test methodology:
  - All stress tests kept at default settings (historical average minus one standard deviation, or baseline projection minus one standard deviation, whichever is lower), plus tailored tests.
  - Tailored natural disaster shock: one-off addition to debt of 10 percentage points of GDP in FY2019/20; growth and exports lowered by 1.5 and 3.5 percentage points respectively in the shock year.
- Key stress test results:
  - External DSA: risk of external debt distress is low. PV of external debt and debt service ratios remain below thresholds in baseline and stress tests.
  - Exports shock: among shocks, the exports shock affects PV of debt ratios the most.
  - Natural disaster shock: important vulnerability for Nepal.
  - Public DSA: risk of public debt distress is low; debt and debt service indicators remain below indicative thresholds across scenarios.
  - Vulnerability to growth shock: a growth shock (1 standard deviation in 2018/19–2019/20) would raise PV of debt-to-GDP to 38 percent of GDP in 2028/29 and debt service-to-revenue to 14.1 percent in 2028/29.

### External and public sustainability indicators (summary)
- External:
  - PV of external debt in percent of GDP: 13.2 percent (net present value estimate).
  - External debt amount: US$4,781 million (17.4 percent of GDP).
- Public:
  - Public debt: 30 percent of GDP in mid-2018; projected 42 percent of GDP by FY2038/39 under baseline.
  - PV of total public debt benchmark: 70 percent of GDP (benchmark not breached in projections).
  - Debt service-to-revenue ratio: assessed to be stable and to remain within 10 percent of GDP in 2028/29 under baseline.

### Views of the authorities
- Authorities broadly agreed with the DSA analysis and assessment.
- Authorities priorities:
  - Achieve domestic revenue targets.
  - Mobilize more concessional external financing to support higher growth.
  - Confidence that Nepal would continue to be at low risk of debt distress despite expansionary macro policies.

### Conclusions and policy recommendations
- Overall assessment: Nepal’s overall risk of debt distress is low; debt and debt service indicators remain below indicative thresholds in baseline and stress tests.
- Key risk factors: growth shocks, exports shocks, and recurrence of natural disasters.
- Policy recommendations:
  - Improve domestic productivity through quality public investment in infrastructure.
  - Strengthen natural disaster prevention and preparedness.
  - Achieve long-term sustainable growth by strengthening the macroeconomic policy framework and tightening monetary and fiscal policy relative to recent expansionary policies.
  - Develop more rigorous analysis on contingent liabilities; collect data on debts from PPPs and external private sector debt.
  - Once fiscal federalism is fully implemented, compile debt data for state and local governments.

*Source: IMF staff analysis as presented in the provided PDF chapter/section.*

### 1990. The size of 3-year adjustment from program inception is found on the horizontal axis; the

### 1nplea2019001 - 1990. The size of 3-year adjustment from program inception is found on the horizontal axis; the

### 3-Year Adjustment in Primary Balance (Percentage points of GDP)
- Horizontal axis description: "The size of 3-year adjustment from program inception is found on the horizontal axis;"
- Vertical axis description: "the percent of sample is found on the vertical axis."
- Axis tick/label values as shown:
  - Vertical axis: 0 2 4 6 8 10 12 14
  - Horizontal axis (negative to positive): -4 .5-4 .0-3 .5-3 .0-2 .5-2 .0-1 .5-1 .0-0 .5 0. 00. 5 1. 01. 52. 02. 53. 03. 54. 04. 55. 05. 56. 06. 57. 07. 58. 0
- Labels and annotations present in the figure/text:
  - "3-Year Adjustment in Primary Balance"
  - "Fiscal Adjustment and Possible Growth Paths 1/"
  - "Mo re"
  - "Distribution 1/"
  - "Pr ojec t ed 3-yr adjustment"
  - "3-year PBadju stment greater than"

### Observations conveyed by the content unit
- The figure conveys a distribution of 3-year primary balance adjustments measured in percentage points of GDP across a sample (vertical axis shows percent of sample).
- The horizontal axis spans negative adjustments (as low as "-4 .5") through positive adjustments (up to "8. 0"), using the exact tick formatting shown.
- The content links the distribution of 3-year primary balance adjustments to "Fiscal Adjustment and Possible Growth Paths 1/".

*Source: 1nplea2019001 - 1990. The size of 3-year adjustment from program inception is found on the horizontal axis; the*

### 2.5 percentage points of GDP in

### 1nplea2019001 - 2.5 percentage points of GDP in

### External debt and balance-sheet indicators (Baseline, 2018–2039)
- External debt (nominal) (In percent of GDP): 2018: 17.4; 2019: 20.2; 2020: 21.8; 2021: 22.5; 2022: 23.0; 2023: 23.0; 2024: 22.5; 2029: 26.3; 2039: 34.7; additional entries: 19.9, 23.1.
- Change in external debt (In percent of GDP): 2018: 1.8; 2019: 2.8; 2020: 1.5; 2021: 0.7; 2022: 0.5; 2023: 0.0; 2024: -0.5; 2029: 1.1; 2039: 0.6.
- Identified net debt-creating flows (In percent of GDP): 2018: 5.4; 2019: 7.4; 2020: 10.3; 2021: 7.1; 2022: 4.5; 2023: 3.0; 2024: 2.3; 2029: 1.8; 2039: 0.0; later entries include -3.7 and 4.0.
- Non-interest current account deficit (In percent of GDP): 2018: 8.0; 2019: 9.5; 2020: 12.4; 2021: 9.0; 2022: 6.4; 2023: 5.0; 2024: 4.4; 2029: 4.0; 2039: 2.6; additional entry: -1.8.
- Deficit in balance of goods and services (In percent of GDP): 2018: 37.6; 2019: 44.0; 2020: 45.0; 2021: 41.1; 2022: 38.0; 2023: 35.6; 2024: 33.9; 2029: 28.8; 2039: 16.0; 2020 also shows 28.4 and 35.5 in different columns.
- Exports (In percent of GDP): 2018: 9.0; 2019: 9.9; 2020: 9.8; 2021: 9.7; 2022: 9.7; 2023: 9.4; 2024: 9.5; 2029: 9.2; 2039: 9.0.
- Imports (In percent of GDP): 2018: 46.6; 2019: 53.9; 2020: 54.7; 2021: 50.9; 2022: 47.8; 2023: 45.0; 2024: 43.4; 2029: 38.0; 2039: 24.9.
- Net current transfers (negative = inflow) (In percent of GDP): 2018: -28.7; 2019: -33.1; 2020: -31.3; 2021: -30.8; 2022: -30.2; 2023: -29.2; 2024: -28.1; 2029: -23.3; 2039: -16.6; additional entries: -28.9, -28.0.
- Net FDI (negative = inflow) (In percent of GDP): 2018: -0.6; 2019: -1.1; 2020: -1.1; 2021: -1.1; 2022: -1.1; 2023: -1.1; 2024: -1.2; 2029: -1.4; 2039: -1.4; other entries: -0.4, -1.2.
- Residual (In percent of GDP): 2018: -3.7; 2019: -4.6; 2020: -8.7; 2021: -6.4; 2022: -4.0; 2023: -3.0; 2024: -2.8; 2029: -0.7; 2039: 0.6; additional: 2.4, -3.2.
- Sustainability indicators:
  - PV of PPG external debt-to-GDP ratio (In percent): 2018: 13.2; 2019: 14.8; 2020: 14.6; 2021: 14.5; 2022: 14.4; 2023: 14.0; 2024: 13.6; 2029: 13.4; 2039: 14.7.
  - PV of PPG external debt-to-exports ratio: 2018: 147.3; 2019: 148.5; 2020: 149.7; 2021: 148.9; 2022: 147.5; 2023: 148.8; 2024: 142.4; 2029: 155.4; 2039: 163.8.
  - PPG debt service-to-exports ratio: 2018: 8.7; 2019: 7.6; 2020: 7.3; 2021: 7.3; 2022: 7.1; 2023: 7.2; 2024: 6.7; 2029: 6.8; 2039: 7.7.
  - PPG debt service-to-revenue ratio: 2018: 3.2; 2019: 2.7; 2020: 2.5; 2021: 2.5; 2022: 2.4; 2023: 2.3; 2024: 2.2; 2029: 2.1; 2039: 2.4.
- Gross external financing need (Million of U.S. dollars): 2018: 2,352.6; 2019: 2,640.6; 2020: 3,953.9; 2021: 3,091.9; 2022: 2,352.5; 2023: 1,944.1; 2024: 1,800.0; 2029: 2,313.4; 2039: 3,154.8.
- PV of PPG external debt (in Million of U.S. dollars): 3,817.0; 4,150.0; 4,433.6; 4,832.2; 5,226.9; 5,603.3; 6,003.8; 9,236.3; 21,758.9.

### Key macroeconomic assumptions (Baseline)
- Real GDP growth (in percent): 2018: 6.3; 2019: 6.5; 2020: 6.3; 2021: 4.5; 2022: 4.5; 2023: 5.0; 2024: 5.0; 2029: 4.5; 2039: 4.6; later entry: 4.9.
- GDP deflator in US dollar terms (change in percent): 2018: 9.0; 2019: -5.8; 2020: 7.5; 2021: 4.5; 2022: 4.1; 2023: 4.0; 2024: 3.8; 2029: 4.0; 2039: 4.0; additional: 4.2, 3.4.
- Effective interest rate (percent) 4/: 2018: 1.4; 2019: 0.8; 2020: 0.8; 2021: 0.8; 2022: 0.8; 2023: 0.8; 2024: 0.8; 2029: 0.6; 2039: 1.0; extra entry: 0.8.
- Growth of exports of G&S (US dollar terms, in percent): 2018: 14.4; 2019: 11.0; 2020: 12.2; 2021: 9.0; 2022: 8.7; 2023: 5.7; 2024: 10.0; 2029: 8.2; 2039: 8.5; additional: 6.0, 8.7.
- Growth of imports of G&S (US dollar terms, in percent): 2018: 25.6; 2019: 16.2; 2020: 16.0; 2021: 1.4; 2022: 2.2; 2023: 3.0; 2024: 5.0; 2029: 5.6; 2039: -11.5; other entries: 13.6, 6.6.
- Grant element of new public sector borrowing (in percent): 2019: 50.7; 2020: 50.6; 2021: 50.8; 2022: 50.8; 2023: 50.7; 2024: 50.7; 2029: 50.9; 2039: 51.1; average: 50.8.
- Government revenues (excluding grants, in percent of GDP): 2018: 24.3; 2019: 28.0; 2020: 28.2; 2021: 28.5; 2022: 28.8; 2023: 29.2; 2024: 29.4; 2029: 29.4; 2039: 29.1; additional entry: 18.3 and 29.0 appear as memoranda.
- Aid flows (in Million of US dollars) 5/: 329.6; 1011.3; 1,171.4; 1,126.6; 1,161.0; 1,161.7; 1,127.0; 2,093.3; 3,399.5; 8.
- Grant-equivalent financing (in percent of GDP) 6/: 2.9; 2.5; 3.0; 2.8; 2.7; 2.6; 2.4; 2.4; 2.6.
- Grant-equivalent financing (in percent of external financing) 6/: 63.9; 66.4; 67.0; 67.8; 69.1; 69.7; 67.5; 67.5; 67.3.
- Nominal GDP (Million of US dollars): 28,812; 28,922; 33,035; 36,067; 39,234; 42,825; 46,664; 70,484; 161,726.
- Nominal dollar GDP growth: 15.8; 0.4; 14.2; 9.2; 8.8; 9.2; 9.0; 8.7; 8.7; 9.0; 8.5.

### Public sector debt (Baseline, 2018–2039)
- Public sector debt (In percent of GDP): 2018: 30.4; 2019: 33.1; 2020: 34.1; 2021: 33.8; 2022: 33.5; 2023: 32.6; 2024: 31.9; 2029: 34.5; 2039: 41.8; additional: 31.7, 33.0.
- Of which: external debt (In percent of GDP): same series as external debt: 17.4; 20.2; 21.8; 22.5; 23.0; 23.0; 22.5; 26.3; 34.7; 19.9; 23.1.
- Change in public sector debt (In percent of GDP): 2018: 4.0; 2019: 2.6; 2020: 1.0; 2021: -0.3; 2022: -0.4; 2023: -0.8; 2024: -0.8; 2029: 0.9; 2039: 0.5.
- Identified debt-creating flows (In percent of GDP): 2018: 4.3; 2019: 2.6; 2020: 1.1; 2021: -1.2; 2022: -1.3; 2023: -1.7; 2024: -1.7; 2029: 0.1; 2039: -0.1; later entry: -2.2; -0.3.
- Primary deficit (In percent of GDP): 2018: 6.0; 2019: 4.3; 2020: 4.4; 2021: 1.2; 2022: 1.1; 2023: 0.7; 2024: 0.7; 2029: 2.4; 2039: 2.7; other entries: 0.3, 2.0.
- Revenue and grants (In percent of GDP): 25.5; 29.2; 29.4; 29.9; 30.2; 30.6; 30.8; 30.6; 30.3; 20.5; 30.3.
- Primary (noninterest) expenditure (In percent of GDP): 31.5; 33.5; 33.7; 31.2; 31.3; 31.3; 31.5; 33.0; 33.0; 20.8; 32.2.
- Automatic debt dynamics (In percent of GDP): 2018: -1.7; 2019: -1.7; 2020: -3.3; 2021: -2.5; 2022: -2.3; 2023: -2.4; 2024: -2.3; 2029: -2.3; 2039: -2.8.
- PV of public debt-to-GDP ratio (In percent): 2018: 26.9; 2019: 27.6; 2020: 27.1; 2021: 26.0; 2022: 25.0; 2023: 23.8; 2024: 23.0; 2029: 22.7; 2039: 22.0.
- PV of public debt-to-revenue and grants ratio (In percent): 105.6; 94.6; 92.3; 86.7; 82.6; 77.8; 74.6; 73.4; 72.7; 72.2; 72.4.
- Debt service-to-revenue and grants ratio (In percent): 4/: 4.7; 7.8; 7.8; 8.3; 8.4; 8.4; 8.4; 8.4; 9.1; 7.7.
- Gross financing need (In percent of GDP): 7.2; 6.6; 6.7; 3.7; 3.6; 3.3; 3.2; 5.2; 5.0.

### Public debt sensitivity and stress tests (2019–2029)
- PV of debt-to-GDP ratio (Baseline): 2019: 14.8; 2020: 14.6; 2021: 14.5; 2022: 14.4; 2023: 14.0; 2024: 13.6; 2025: 13.4; 2026: 13.2; 2027: 13.6; 2028: 14.0; 2029: 14.3.
- Selected bound tests (example outcomes):
  - B1. Real GDP growth: PV of debt-to-GDP remains similar around 14.8–14.3 across 2019–2029.
  - B5. One-time 30 percent nominal depreciation: PV of debt-to-GDP shows declines to as low as 10.5 (2021) and rises in later years.
  - Combined shock (B6): PV of debt-to-GDP rises to 20.6 in 2020 and remains elevated through projection years.
- Debt service-to-exports ratio (Baseline): 7.6; 7.3; 7.3; 7.1; 7.2; 6.7; 6.3; 6.4; 6.4; 6.6; 6.8.
- PV of debt-to-exports ratio (Baseline): 148.5; 149.7; 148.9; 147.5; 148.8; 142.4; 141.4; 141.1; 146.4; 151.0; 155.4.
- Debt service-to-revenue ratio (Baseline): 2.7; 2.5; 2.5; 2.4; 2.3; 2.2; 2.0; 2.0; 2.0; 2.1; 2.1.

### Authorities' statement: recent developments, outlook, and policies
- Growth and outlook:
  - Real GDP growth: 6.3 percent in fiscal year 2017/18; projected to remain around 8 percent in fiscal year 2018/19.
  - Authorities target reaching double digit growth and graduating to middle-income country status by 2030.
- Inflation:
  - Average annual inflation moderated to 4.2 percent in fiscal year 2017/18 (down from 4.5 percent).
  - Average overall inflation stood at 4.1 percent as of mid-December 2018.
  - Food inflation: 0.5 percent; non-food inflation: 6.3 percent (as of mid-December 2018).
- External sector and reserves:
  - Overall BOP deficit: 1.1 million dollars at end of fiscal year 2017/18; widened to 750 million dollars in mid-December 2018.
  - Foreign exchange reserves adequate to cover imports of merchandise goods and services for 7.8 months.
- Fiscal policy and management:
  - Authorities welcome the Debt Sustainability Analysis assessment that risk of debt distress remains low.
  - Transition to fiscal federalism and reconstruction activities have increased government spending; deficits expected to normalize once resources and responsibilities to local and state governments are fixed.
  - Fiscal federalism features rule-based and transparent fiscal transfer and revenue sharing mechanisms; local consolidated funds to monitor sub-national finances; medium-term expenditure framework to be set up.
  - Government revenue collection growth exceeded 26 percent in the first six months of the fiscal year versus an average growth of 20 percent in the last decade.
  - Revenue administration reforms include: improvement of the tax system, strategic plan for inland revenue management, customs valuation and control reforms with risk management, adoption of e-payment system, establishment of a revenue board, and zero tolerance for revenue leakage.
  - A Public Expenditure Review Commission has been established to review development project evaluations, investment procedures, program budgeting, integrated social security system, and the fiscal rule.
- Monetary, exchange rate, and financial sector:
  - Monetary policy stance considered appropriate to maintain price and external sector stability while facilitating high, sustainable growth.
  - Real interest rate on deposits is positive; average deposit rate has remained above 6 percent while inflation averaged about 4 percent.
  - The peg to the Indian rupee continues to serve as a transparent nominal anchor.
  - Concerns on recent credit growth were noted; authorities ensure credit growth remains supportive but not excessive.
  - Non-performing loans: 1.6 percent in mid-July 2018.
  - Macroprudential measures in place: CCD ratio, limits on real estate exposures, CRR, LTV ratio on car loans.
  - Risk-based supervision practices revised to full scope and targeted supervision.
  - Progress on financial inclusion: Financial Inclusion Action Plan launched; directives for microfinance; mobile banking and internet banking expanded; target of at least one commercial bank branch in each local administrative unit with 703 branches established out of 753 local levels as of mid-January 2018.
  - Directed credit/priority sector lending is small in size and targeted to ultra-poor and inaccessible populations.
- Structural reform and governance:
  - Priorities: agricultural transformation, hydro power generation, boosting tourism, SME performance, revival of construction sector, job creation, accelerating economic reforms, promoting inclusive growth, and improving investment climate.
  - Authorities committed to zero tolerance on corruption; governance measures include code of conduct for staff, close monitoring, and revisions to public procurement law to increase transparency and competitiveness.
- Investment promotion:
  - Amendments underway to more than three dozen investment-related laws including FITTA, PPP Act, Procurement Act, and Investment Board of Nepal Act.
  - Plans to hold an International Investment Summit in March 2019 and promote Visit Nepal Year 2020.

*Sources: Country authorities; and staff estimates and projections.*

### 2019. This will be an excellent avenue for them to share the long awaited political stability

### 1nplea2019001 - 2019. This will be an excellent avenue for them to share the long awaited political stability

### Tourism and investment outlook
- Government announced the year 2020 as the Visit Nepal Year with targeting two million tourists.
- Political stability achieved in 2019 is seen as an avenue to encourage a business environment and explore investment prospects in Nepal.

### AML/CFT
- Authorities prioritize implementing AML/CFT measures, "internalizing it as a part of good governance and bringing them in line with international standards."
- With the successful implementation of the first AML/CFT National Strategy and Action Plan:
  - The authorities have completed the AML/CFT self-assessment.
  - The authorities are in the process of finalizing the second AML/CFT National Strategy and Action Plan for 2019 to 2024.

### Capacity development needs
- Authorities appreciate Fund support to enhance technical capacity in fiscal, monetary, legal, and financial statistics areas.
- Key capacity gaps and requests:
  - Technical capacity enhancement remains critical during the changed environment.
  - Request for technical support to strengthen fiscal and financial information system at the sub-national level.
  - Need to enhance technical capacity to revisit and rebase the national GDP and disaggregate it up to sub national level.

### Final remarks
- Authorities thank the Fund for the successful conclusion of the Article IV consultation in Nepal.
- Authorities express gratitude to the Fund for continued policy advice and technical assistance and to the donor community for continued assistance and support to Nepal.
- Authorities look forward to continuing discussions with the Fund on macroeconomic and financial sector policies including structural reforms.

*Source: 1nplea2019001 - 2019. This will be an excellent avenue for them to share the long awaited political stability*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1nplea2019001.pdf_