## 1nplea2020001

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### Recent developments and outlook
- Real GDP growth: 7.1 percent in 2018/19; growth expected to ease to 6 percent in FY2019/20.
- Headline CPI: expected at 6 percent in FY2019/20 due to high food inflation; headline inflation rose to 6.5 percent in December 2019 (y/y).
- Current account and reserves:
  - Current account deficit: 7.7 percent of GDP in FY2018/19; estimated to have narrowed to 4.3 percent of GDP during the first months of FY2019/20; forecast to narrow to 5.2 percent of GDP in FY2019/20.
  - Gross official reserves: US$8.7 billion in December 2019, covering 6.9 months of prospective imports; table entries include 8,545 and 8,536 (millions of U.S. dollars for related years).
  - External position in FY2018/19 assessed as weaker than the level consistent with fundamentals and desirable policy settings.
- Remittances:
  - Represented 25 percent of GDP in FY2018/19.
  - Workers' remittances (2016/17–2024/25): 6,556; 7,224; 7,769; 8,402; 8,825; 9,270; 9,737; 10,227; 10,742.
  - Remittances in percent of GDP (2016/17–2024/25): 26.0; 24.9; 25.3; 24.7; 23.6; 22.7; 21.9; 21.1; 20.3.
- Credit and financial sector:
  - Credit growth tapered to 14.8 percent (y/y) in December 2019 from 25.4 percent (y/y) a year earlier.
  - Private Sector Credit (percent of GDP, 2016/17–2024/25): 74.7; 80.6; 84.0; 86.0; 87.5; 88.2; 88.9; 89.8; 90.2.
  - Credit rose to 84 percent of GDP in July 2019; official non-performing loans ratio is 1.4 percent.
- Key table projections (selected):
  - Real GDP (annual percent change, 2016/17–2024/25): 8.2; 6.7; 7.1; 6.0; 5.7; 5.5; 5.4; 5.3; 5.3.
  - Headline CPI (period average, 2016/17–2024/25): 4.5; 4.1; 4.6; 6.0; 5.9; 5.8; 5.6; 5.3; 5.3.
  - Gross official reserves (millions of U.S. dollars, 2016/17–2024/25): 9,264; 9,304; 8,545; 8,536; 8,419; 8,233; 8,045; 7,850; 7,673.
  - Gross official reserves (months of prospective imports, 2016/17–2024/25): 8.3; 7.9; 7.0; 6.6; 6.1; 5.5; 5.1; 4.7; 4.3.
  - Current account (millions of U.S. dollars, 2016/17–2024/25): -93; -2,350; -2,369; -1,760; -1,832; -1,963; -2,104; -2,215; -2,323.
  - Current account (percent of GDP, 2016/17–2024/25): -0.4; -8.1; -7.7; -5.2; -4.9; -4.8; -4.7; -4.6; -4.4.
- Note: Data as of January 31, 2020. Fiscal year ends in mid-July.

### Executive Board assessment and risks
- Growth drivers and outlook:
  - Strong recent growth supported by political stability, more reliable electricity supply, and post-earthquake reconstruction spending.
  - FY2019/20 growth expected to ease to 6 percent because of slower growth in India, sluggish remittance inflows, and weaker agricultural production.
- Downside risks:
  - Renewed balance of payments pressures and increased financial-sector risks if credit growth increases sharply or remittances slow down abruptly.
  - External risks include further slowdown in India or GCC countries and higher international oil prices.
  - Natural disaster and climate-change-related risks: flooding and landslides expected to become more frequent and severe over the medium-term.

### Fiscal developments and recommendations
- FY2018/19 fiscal outcome:
  - Central government deficit (net lending/borrowing): narrowed to 4.6 percent of GDP (from -6.7 percent in FY2017/18).
  - Total revenue and grants (percent of GDP, 2016/17–2024/25): 24.1; 25.3; 26.0; 25.8; 26.0; 25.8; 25.5; 25.6; 25.5.
  - Expenditure (percent of GDP, 2016/17–2024/25): 27.2; 31.9; 30.6; 30.4; 30.4; 30.0; 29.7; 29.4; 29.3.
  - Public debt (percent of GDP, 2016/17–2024/25): 26.1; 30.2; 30.1; 33.7; 35.7; 37.4; 39.0; 40.3; 41.1.
- Fiscal stance guidance and policy recommendations:
  - A fiscal deficit of 4.5 percent of GDP, similar to FY2018/19 outcome, would be prudent.
  - Adopt a neutral fiscal stance to contain external pressures and protect fiscal sustainability.
  - Align overall SNG expenditure envelope with available funding; impose tight limits on subnational borrowing.
  - Use a top-down budget process and MTFF based on conservative revenue and expenditure assumptions.
  - Improve expenditure quality and timely execution; devote more resources to procurement monitoring and project execution oversight.

### Monetary and financial sector recommendations
- Macroprudential and supervisory actions:
  - Continue macroprudential measures to limit systemic risk; resist any relaxation of the CCD ratio and be ready to tighten it if sharp credit growth resumes.
  - Maintain activation of the 2 percent countercyclical capital buffer by July 2020.
  - Require banks to cross-check corporate borrowers’ financial information against the Integrated Tax System (ITS).
  - Strengthen monitoring of asset quality, curtail evergreening practices, and enhance monitoring of concentration risk (harmonize group codes).
- Interest rate framework and operations:
  - Strengthen interest rate framework to reduce volatility in short-term interest rates.
  - Introduce a standing deposit facility as a first step toward a reliable interest rate corridor (IRC).
  - Anchor short-term market rates near the policy rate through regular open market operations once IRC track record is established.
- NRB governance and capacity:
  - Modernize NRB governance to improve autonomy and accountability: strengthen independent oversight, safeguard institutional and personal autonomy, enhance internal controls and quality of external audit.
  - Improve human resource management: reduce frequency of rotation, enable on-the-job training and specialization.

### Transition to fiscal federalism
- Devolution:
  - Responsibilities being devolved to 7 provincial and 753 local governments.
  - Potential benefits: improved service delivery and strengthened accountability.
  - Key challenge: spending pressures and weak capacity of subnational governments (SNGs).
- Implementation and risks:
  - SNG budget execution rates averaged about 60 percent in FY2018/19.
  - Insufficient data on SNG operations; financial reporting system yet to be implemented.
  - Policy recommendations: anchor central and subnational budgets in an MTFF; align SNG expenditure with funding; develop robust reporting and monitoring system; set tight limits on subnational borrowing.

### Structural reforms and growth strategy
- Objective: transition from consumption to investment to reach middle-income status by 2030 under the development plan ‘Prosperous Nepal, Happy Nepalis’.
- Key reform priorities:
  - Encourage high-quality investment projects, in particular FDI; reduce FITTA foreign-investor threshold of 500,000 USD to attract SMEs.
  - Ensure an enabling implementation environment for infrastructure projects and FDI as post-earthquake reconstruction spending draws to a close.
  - Improve staffing, skills matching, and align incentives across ministries for project approvals, implementation, and monitoring.
  - Streamline approvals process; strengthen public procurement enforcement and monitoring; expand hydropower and tourism.
  - Factor climate-change mitigation and adaptation into the medium-term economic framework; adhere to disaster-proof building codes.

### Financial sector soundness, supervision, and inclusion (Annex V highlights)
- Infrastructure and inclusion:
  - Improvements in electricity, mobile, and internet networks foster fintech payments and greater financial service usage.
  - Real Time Gross Settlement System launched in November 2019.
- FSAP policy recommendations (paragraphs 26–30):
  - Strictly enforce macroprudential measures; maintain CCD ratio and other limits.
  - Support banks cross-checking borrower data against ITS.
  - Curtail evergreening; finalize housing price index for monitoring real estate exposure.
  - Harmonize group codes for largest 50 business groups and include them in SIS reporting.
  - Strengthen risk-based off-site supervision using the Supervisory Information System (SIS).
  - Enhance fintech-driven financial inclusion while reducing compliance burdens and increasing financial literacy.
- Authorities’ intent:
  - Authorities broadly agreed to maintain macroprudential measures and monitor asset quality; plan to expand digital banking and branch coverage.

### External Sector Assessment (Annex I highlights)
- Overall assessment:
  - External position in 2018/19 assessed as weaker than level consistent with fundamentals and desirable policy settings.
  - Large current account deficit reflects high imports due to earthquake reconstruction and strong domestic demand.
  - Net IIP: Nepal was a net creditor with net IIP at US$1.4 billion (4.8 percent of GDP) as at mid-July 2019.
- EBA-lite results:
  - Current account norm: a deficit of 3.8 percent of GDP in FY2018/19; model indicates a CA-gap of between -2.8 to -4.8 percent of GDP.
  - REER: by mid-July 2019 Nepal’s REER estimated to be 21 percent more appreciated than the equilibrium REER (reported REER gap21.8%, Ln(REER) actual4.67, Ln(REER) norm4.46, REER gap20.9%).
  - To close the CA-gap, estimated REER depreciation between 15 to 27 percent (assuming trade-balance elasticity -0.18).
  - Large positive net errors and omissions amounted to 2.7 percent of GDP in FY2018/19.
- Reserves adequacy:
  - Central bank reserves fell to US$8.5 billion at mid-July 2019 from a peak of US$9.5 billion in mid-January 2018.
  - ARA-CC suggests adequate reserves equivalent to about 7 months of prospective imports; alternative specifications raise adequate level to 4.2 months.
  - Gross official reserve coverage expected to decline to 4.3 months of prospective imports by FY2024/25.
- Policy implications:
  - Domestic monetary/financial policies have a significant role in addressing the current account gap; maintain prudent macroeconomic policies and address structural constraints (infrastructure, red tape).

### Debt sustainability and public debt coverage
- Coverage and stock:
  - Coverage includes central and local government debts, government guarantees, and central bank borrowing.
  - Total public debt: 30.1 percent of GDP at mid-2019.
  - External public debt: 17 percent of GDP at mid-July 2019; NPV of external debt about 12.2 percent of GDP.
  - Domestic public debt: 13.1 percent of GDP at mid-July 2019.
- Debt composition (end FY2018/19, selected table figures):
  - Total external (millions of US$): 5,366 — 17.0% of GDP.
  - Multilateral: 4,760 — 15.1% of GDP — 89% of external debt.
  - Total domestic (billions of Nepalese rupees): 453 — 13.1% of GDP.
  - Treasury bills: 147 — 4.2% of GDP — 32% of domestic debt.
  - Treasury bonds: 306 — 8.8% of GDP — 68% of domestic debt.
- Contingent liabilities and exposures:
  - SOE debt: 2 percent of GDP (included in contingent liability stress test).
  - PPP projects: 2.1 percent of GDP (contingent liability stress test); PPI database estimates PPP contracts about 6 percent of GDP as of 2017.
  - Government guarantee to Nepal Airlines Corporation for aircraft purchase: 1.0 percent of GDP in FY2018/19.
- DSA findings:
  - Nepal remains at low risk of debt distress (LIC-DSF); all debt and debt service indicators projected to be below indicative threshold values under baseline and stress tests.
  - Public debt projected to increase gradually over medium-term owing to continuing fiscal and current account deficits.
  - Public sector debt projected path (selected): public sector debt (percent of GDP timeline): 30.1; 33.7; 35.7; 37.4; 39.0; 40.3; 41.1 (selected years and projections across tables).
- Fiscal financing assumptions:
  - Primary deficit outturn FY2018/19: 4.0 percent of GDP; projected FY2019/20 primary deficit: 3.9 percent of GDP.
  - Domestic borrowing expected to rise to meet fiscal deficits; domestic borrowing expected to reach 4 percent of GDP annually; domestic debt stock projected to increase from 13 percent to 35½ percent of GDP over the long-term while external debt projected to decrease.

### Progress on FSAP 2014 high-priority recommendations (Annex V highlights)
- Financial stability and oversight:
  - RTGS in full operation since November 22, 2019.
  - Asset Quality Review (AQR): Fully Implemented.
  - Prompt Corrective Action (PCA) revisions: Fully implemented.
  - NRB Act revisions: ELA provisions revised (Done); special resolution regime powers granted (Fully implemented).
  - Supervisory Information System (SIS): pilot launched January 8, 2020.
  - Several recommendations remain "In process" or "Not done": Treasury sterilization bonds and refocusing monetary operations (Not done); redefinition of licensing/regulatory consolidation (Not done); strengthening operational independence of IB and SEBON (Not done).
  - Crisis Management Co-ordination Committee formed (Done); periodic crisis simulations: Not done.

### Data, technical assistance, and institutional capacity
- Data and statistics:
  - Ongoing rebasing of national accounts to 2010/11 base year for SNA2008 compliance; major revision planned in 2020.
  - BOP data dissemination moving to BPM6; improvements aided by STA technical assistance.
  - Note: Data as of January 31, 2020.
- Fund relations and TA:
  - Technical assistance across MCM, SARTTAC, STA, and others on supervision, internal audit, statistics, and fiscal federalism.
  - Resident Representative: Mr. Luis Breuer (Senior Resident Representative since July 26, 2019, based in New Delhi).
- Exchange rate and arrangements:
  - Conventional peg: Nepalese rupee pegged to the Indian rupee at NRs 1.6 per Indian rupee (since 1994).
  - As of January 30, 2020, exchange rate: US$1 = Nrs. 114.2.

*Source: IMF staff report for the 2020 Article IV Consultation (data and text as of end-January 2020).*

### 7.7 percent of GDP in FY2018/19, with remittances helping to finance the large trade deficit.

### 7.7 percent of GDP in FY2018/19, with remittances helping to finance the large trade deficit.

### Recent developments and outlook
- Real GDP growth: 7.1 percent in 2018/19; growth expected to ease to 6 percent in FY2019/20.
- Inflation: Headline CPI expected at 6 percent in FY2019/20 due to high food inflation.
- Current account and reserves:
  - External position in FY2018/19 assessed as weaker than the level consistent with fundamentals and desirable policy settings.
  - Current account deficit narrowed during first months of FY2019/20 due to lower imports of fuel and construction material.
  - Gross official reserves: US$8.7 billion in December 2019, remaining adequate at 6.9 months of prospective imports (text also notes 8,545 and 8,536 in related table entries).
- Remittances:
  - Represented 25 percent of GDP in FY2018/19.
  - Recent deceleration in remittance inflows due to slowdown in major remittance-sending economies, including India.
  - Workers' remittances (table): 6,556; 7,224; 7,769; 8,402; 8,825; 9,270; 9,737; 10,227; 10,742 (2016/17–2024/25).
  - Remittances in percent of GDP (table): 26.0; 24.9; 25.3; 24.7; 23.6; 22.7; 21.9; 21.1; 20.3 (2016/17–2024/25).
- Credit and financial sector:
  - Credit growth tapered to 14.8 percent (y/y) in December 2019 compared to 25.4 percent (y/y) a year earlier.
  - Credit as a share of GDP remains elevated relative to peers.
  - Private Sector Credit (in percent of GDP) (table): 74.7; 80.6; 84.0; 86.0; 87.5; 88.2; 88.9; 89.8; 90.2 (2016/17–2024/25).

### Executive Board assessment and risks
- Growth drivers and outlook:
  - Recent strong growth supported by a stable political environment, more reliable electricity supply, and post-earthquake reconstruction spending.
  - FY2019/20 growth expected to ease to 6 percent due to slower growth in India, sluggish remittance inflows, and weaker agricultural production.
- Risks:
  - Downside risks include renewed balance of payments pressures and increased financial-sector risks if credit growth were to increase sharply or remittances slow down abruptly.
  - External position in FY2018/19 assessed as weaker than fundamentals and desirable policy settings.

### Fiscal developments and recommendations
- FY2018/19 fiscal outcome:
  - Central government deficit narrowed to 4.6 percent of GDP due to improvements in revenue collection and underspending relative to budget.
  - Provinces and local governments also saw spending under-execution.
- Fiscal stance guidance:
  - A fiscal deficit of 4.5 percent of GDP, similar to the outcome in FY2018/19, would be prudent.
  - Fiscal policy should be geared towards containing external pressures and protecting fiscal sustainability.
  - A neutral fiscal stance—which would entail under-execution of the budget as observed in previous years—would help contain external and domestic pressures.
  - The overall expenditure envelope of subnational governments (SNGs) needs to be aligned with available funding, with tight limits on any subnational borrowing.
  - A top-down budget process and MTFF based on conservative revenue and expenditure assumptions is recommended to instill greater prioritization and avoid creating unrealistic revenue expectations among SNGs.
  - Further efforts needed to ensure spending is of high quality and executed in a timely manner.
- Public debt and fiscal aggregates (table highlights):
  - Net lending/borrowing (central government, percent of GDP): -3.1; -6.7; -4.6; -4.5; -4.4; -4.2; -4.1; -3.9; -3.7 (2016/17–2024/25).
  - Total revenue and grants (percent of GDP): 24.1; 25.3; 26.0; 25.8; 26.0; 25.8; 25.5; 25.6; 25.5 (2016/17–2024/25).
  - Expenditure (percent of GDP): 27.2; 31.9; 30.6; 30.4; 30.4; 30.0; 29.7; 29.4; 29.3 (2016/17–2024/25).
  - Public debt (percent of GDP): 26.1; 30.2; 30.1; 33.7; 35.7; 37.4; 39.0; 40.3; 41.1 (2016/17–2024/25).

### Monetary and financial sector recommendations
- Continue macroprudential measures to limit buildup of systemic risk in the financial sector.
- The Nepal Rastra Bank (NRB) actions and recommendations:
  - Implemented macroprudential measures, strengthened bank supervision and regulation, introduced a supervisory information system, and implemented selected elements of the Basel III capital framework.
  - Recent regulatory requirement for banks to cross-check corporate borrowers’ financial information against the ITS expected to facilitate more prudent risk assessment by banks.
  - Activation of the countercyclical capital buffer requiring banks to increase their level of capital by July 2020 is appropriate.
  - NRB should continue to closely monitor asset quality of banks and improve monitoring of concentration risk.
- Interest rate framework:
  - Strengthen the interest rate framework to reduce volatility in short-term interest rates.
  - Staff emphasizes the need to introduce a standing deposit facility as a first step towards establishing a reliable implementation track record for the interest rate corridor.
- Governance and institutional reforms:
  - Modernize NRB governance framework to improve autonomy and accountability.
  - Reforms needed to strengthen independent oversight, safeguard institutional and personal autonomy, enhance internal controls and quality of external audit, underpinned by supportive human resource management.

### Structural reforms and growth strategy
- Transition from consumption to investment emphasized to reach middle-income status by 2030 under the development plan ‘Prosperous Nepal, Happy Nepalis’.
- To boost medium-term growth prospects:
  - Structural reforms to encourage high-quality investment projects, in particular FDI, are critical.
  - Maintain growth momentum as post-earthquake reconstruction spending draws to a close by ensuring an enabling implementation environment for infrastructure projects and FDI.
  - Focus on adequate staffing, better skills matching, and aligning incentives across and within government ministries responsible for project approvals, implementation, and monitoring.

### Key statistics and projections (selected from table)
- Real GDP (annual percent change): 8.2; 6.7; 7.1; 6.0; 5.7; 5.5; 5.4; 5.3; 5.3 (2016/17–2024/25).
- Headline CPI (period average): 4.5; 4.1; 4.6; 6.0; 5.9; 5.8; 5.6; 5.3; 5.3 (2016/17–2024/25).
- Gross official reserves (millions of U.S. dollars): 9,264; 9,304; 8,545; 8,536; 8,419; 8,233; 8,045; 7,850; 7,673 (2016/17–2024/25).
- Gross official reserves (in months of prospective imports): 8.3; 7.9; 7.0; 6.6; 6.1; 5.5; 5.1; 4.7; 4.3 (2016/17–2024/25).
- Current account (in millions of U.S. dollars): -93; -2,350; -2,369; -1,760; -1,832; -1,963; -2,104; -2,215; -2,323 (2016/17–2024/25).
- Current account (percent of GDP): -0.4; -8.1; -7.7; -5.2; -4.9; -4.8; -4.7; -4.6; -4.4 (2016/17–2024/25).
- Trade balance (in millions of U.S. dollars): -8,446; -10,849; -11,373; -11,658; -12,379; -13,140; -13,956; -14,770; -15,643 (2016/17–2024/25).
- Trade balance (percent of GDP): -33.5; -37.4; -37.1; -34.2; -33.1; -32.2; -31.4; -30.5; -29.6 (2016/17–2024/25).
- Broad money (annual percent change): 15.5; 19.4; 15.8; 13.2; 11.9; 11.6; 11.1; 10.9; 10.7 (2016/17–2024/25).
- Domestic credit (annual percent change): 20.2; 26.1; 21.7; 17.6; 15.7; 14.3; 13.8; 13.3; 13.1 (2016/17–2024/25).
- Nominal GDP (in billions of U.S. dollars): 25.2; 29.0; 30.7; 34.1; 37.4; 40.8; 44.5; 48.4; 52.9 (2016/17–2024/25).
- Note: Data as of January 31, 2020. Fiscal year ends in mid-July.

*Source: IMF staff report for the 2020 Article IV Consultation (data and text as of end-January 2020).*

### 5.      The transition to fiscal federalism is proceeding as mandated by the 2015 constitution,

### 5.      The transition to fiscal federalism is proceeding as mandated by the 2015 constitution, 

### Transition to fiscal federalism
- Responsibility for the provision of many public services is being devolved to 7 provincial and 753 local governments.
- Potential benefits: improve service delivery and strengthen accountability.
- Key challenge: spending pressures and weak capacity of subnational governments (SNGs).

### Recent developments, outlook, and risks
- Growth and inflation
  - GDP growth increased to 7.1 percent in FY2018/19 (mid-July 2018 to mid-July 2019) from 6.7 percent in FY2017/18.
  - Headline inflation rose to 6.5 percent in December 2019, compared to 3.7 percent a year earlier.
- Current account and reserves
  - Current account deficit was 7.7 percent of GDP in FY2018/19.
  - During the first months of FY2019/20, estimated current account deficit narrowed to 4.3 of GDP.
  - Gross official reserves were US$8.7 billion in December 2019, equal to 6.9 months of prospective imports.
  - External position in FY2018/19 assessed as weaker than the level consistent with fundamentals and desirable policy settings.
- Credit and financial sector
  - Credit growth eased to 14.8 percent (y/y) in December 2019 from 25.4 percent (y/y) a year earlier.
  - Credit rose to 84 percent of GDP in July 2019.
  - Official non-performing loans ratio is 1.4 percent.
  - All banks are exceeding the regulatory capital adequacy ratio of 11 percent.
  - Risks to asset quality from evergreening practices and difficulty in evaluating consolidated exposure.
- Fiscal developments
  - Budgets for the past three fiscal years featured overall deficit projections of around 8 percent of GDP, but under-execution led to lower deficits.
  - In FY2018/19, the central government deficit narrowed to 4.6 percent of GDP (from 6.7 percent of GDP in FY2017/18).
  - Public debt is around 30 percent of GDP.
- Revenue and tax administration
  - Revenue collection rose to 24.8 percent of GDP in FY2018/19, from 24.0 percent in FY2017/19.
  - Tax administration expanded digitalization for payments and monitoring and introduced a Permanent Account Number (PAN) system.
  - Reforms to customs valuation and adoption of risk-based clearance and an e-payment system implemented.
  - The new Integrated Tax System (ITS) is an on-line portal containing corporations' financial information from tax returns; banks are mandated to cross-check borrower financial statements against the ITS when originating and renewing business loans.
- Near-term forecast (FY2019/20)
  - Growth moderation to 6 percent.
  - Inflation expected to average around 6 percent.
  - Current account deficit forecast to narrow to 5.2 percent of GDP.
  - Foreign exchange reserves expected to stabilize at US$8.5 billion (6.6 months of prospective imports).
- Medium-term projection
  - Growth expected to ease to 5.3 percent.
  - Supporting factors that are waning: earthquake reconstruction, building of administrative infrastructure for subnational governments, and worker remittances from GCC countries linked to major infrastructure projects.
  - Potential supports: expansion of hydropower and tourism, improved government service delivery under fiscal federalism.
- Risks to the outlook (mainly downside)
  - Sharp increase in credit growth could pressure the balance of payments and financial stability.
  - Abrupt slowdown in deposit growth from remittance disruptions could affect liquidity and expose loan portfolio weaknesses.
  - Greater-than-expected government underspending poses downside risk to growth.
  - External risks: further slowdown in India or GCC countries; higher international oil prices.
  - Natural disaster and climate-change-related risks (e.g., flooding and landslides) expected to become more frequent and severe over the medium-term.
  - Upside risks: faster tourism recovery, earlier hydropower project commissioning, or more expeditious implementation of government infrastructure projects.

### Authorities’ views
- Authorities expect growth rates above 8 percent over the medium-term.
- They emphasize favorable export prospects, expansion of tourism (completion of international airports in Lumbini and Pokhara), greater hydropower allowing exports to India and Bangladesh, and full implementation of fiscal federalism stimulating economic activity and more balanced regional development.
- Authorities recognize external headwinds for the current year.

### Policy discussions and recommendations (macro stance)
- Policy mix objective: contain external pressures, protect financial stability, and preserve fiscal sustainability.
- Recommended stance: neutral fiscal stance and careful management of the transition to fiscal federalism.
- Keep credit growth in check by maintaining macroprudential measures.
- Build the monetary policy framework and strengthen financial sector supervision.
- Be ready to tighten fiscal and macroprudential policies if balance of payments pressures reemerge or credit growth increases sharply.
- Expand productive capacity by promoting private investment and an enabling implementation environment for quality projects.

### Monetary and exchange rate policy
- Exchange rate and monetary policy space
  - Exchange rate peg: 1.6 Nepalese rupees per Indian rupee since 1994.
  - Capital controls provide limited room for monetary policy to influence domestic prices.
  - Domestic factors play an important role in driving non-food inflation.
  - Macroprudential policies have been more effective than the interest rate in affecting credit supply.
- Interest rate corridor (IRC) issues
  - IRC deficiencies (including lack of a standing deposit facility) have resulted in highly volatile short-term rates that often fall below the IRC floor.
  - No transmission of short-term rates to deposit and lending rates.
- Central bank governance and capacity
  - Shortcomings in autonomy and accountability of Nepal Rastra Bank (NRB): only three out of seven Board members are independent.
  - NRB Act obliges NRB to follow government directives; a proposed amendment would allow dismissal of NRB senior officials if directives are not followed.
  - Frequent rotation of management and staff undermines capacity building and hampers internal controls.
  - External audit quality falls short of international standards; slow progress on priority recommendations from the 2018 safeguards monitoring visit.
- Policy recommendations for monetary policy
  - Introduce a standing deposit facility to provide a solid floor for the IRC, implying a tightening.
  - Anchor short-term market rates near the policy rate through regular open market operations once the IRC track-record is established.
  - Continue use of macroprudential policies as necessary.
  - Maintain an adequate level of reserves to preserve peg credibility.
  - Legal amendments to the NRB Act to strengthen independent oversight and safeguard institutional and personal autonomy.
  - Enhance internal controls and the quality of external audit.
  - Improve human resource management: reduce frequency of rotation of staff, allow time for on-the-job training and specialization, and align training with responsibilities.

### Financial sector policies
- Macroprudential measures and credit moderation
  - Credit growth in 2018 exceeded prudent levels, but since late 2018 credit has moderated due to CCD ratio binding and reduction in personal overdraft limits.
  - Requirement to cross-check borrowers’ financial information against the ITS has contributed to credit moderation.
  - A 2 percent countercyclical capital buffer by July 2020 has been mandated.
  - A debt service to income ratio for non-business loans was introduced.
- Asset quality concerns
  - Large share of loan portfolio is revolving; about 40 percent consists of overdraft and working capital loans.
  - On-site inspections uncovered evergreening where firms use revolving loans to make interest payments.
  - Lack of harmonized group codes across banks constrains consolidated exposure measurement and monitoring of concentration risk.
  - Significant real estate exposures, including commercial loans collateralized by real estate.
  - Concerns: non-performing loans may be understated, provisioning inadequate, and capital adequacy overstated.
- Supervision and inclusion
  - Progress: several elements of Basel III capital adequacy framework 2015 implemented for commercial banks (including Capital Conservation Buffer, Common Equity Capital, and Leverage Ratio).
  - NRB improved risk-based on-site supervision with Fund support.
  - Supervisory Information System (SIS) launched in pilot phase in January 2020 to improve supervisory data collection and analysis.
  - Off-site supervision remains compliance-focused rather than risk-based; frequent staff rotation hinders capacity development.
  - Financial inclusion is improving, including through fintech; NRB mandates expansion of bank branches (details not included in this excerpt).

*Source: 1nplea2020001 - 5.      The transition to fiscal federalism is proceeding as mandated by the 2015 constitution,*

### Annex V takes stock of 2014 FSAP recommendations.

### Annex V takes stock of 2014 FSAP recommendations.

### Financial sector soundness, supervision, and financial inclusion
- Improvements in infrastructure—such as access to more reliable electricity, mobile, and internet networks—have been conducive to fintech payments and greater usage of financial services by individuals.
- The authorities have taken measures to promote payments service providers; business informality continues to affect access to financing and use of digital services.
- Real Time Gross Settlement System launched in November 2019, addressing systemic settlement risks.

Policy recommendations (paragraphs 26–30)
- Macroprudential measures should continue to be strictly enforced to prevent excessive credit growth.
- The NRB should resist any relaxation of the CCD ratio and stand ready to tighten it if sharp credit growth resumes.
- Staff supports the requirement for banks to cross-check corporate borrowers’ financial information against the ITS in assessing credit limits.
- Activation of the counter cyclical buffer and introduction of debt-service-to -gross-income limits are welcome.
- Asset quality should be closely monitored and evergreening practices curtailed; banks should regularly review companies’ financial statements and adjust credit limits accordingly.
- Finalize the housing price index being developed by the NRB to better monitor real estate exposure risks.
- Enhance monitoring of concentration risk: NRB should urge the bankers’ association to develop a task force to harmonize group codes for the largest 50 business groups; include harmonized group codes in SIS reporting.
- Further strengthen risk-based off-site supervision supported by effective use of the new information system (SIS); develop new processes and a new manual of off-site supervision.
- Enhance financial inclusion through fintech: encourage fintech payments in areas with geographical barriers; reduce compliance burdens, increase benefits of formal services, raise financial literacy; tailor policies and regulations to support healthy fintech development.

Authorities’ views (paragraph 31)
- Authorities broadly agreed with maintaining macroprudential measures and closely monitoring asset quality.
- NRB intends to maintain recent regulatory measures while monitoring their impact on credit developments.
- Expanded coverage of the Credit Information Bureau and inclusion of the Permanent Account Number in SIS reporting expected to facilitate monitoring of credit exposure.
- Plan to expand digital banking in remote areas, supplementing expansion of bank branches to almost all localities.

### Fiscal policy, budget execution, and fiscal federalism
Findings and projections
- The FY2019/20 budget targets an ambitious increase in both revenue and spending; effective stance will depend on implementation.
- Budgeted tax revenue increase appears overly optimistic compared to measures described in the budget; staff projects tax revenues will remain broadly flat as a share of GDP.
- Government expenditure is budgeted to be 8 percentage points of GDP higher than last year’s outcome.
- Full implementation of the budget would result in a central government deficit of 8.3 percent of GDP.
- Staff projects a central government deficit of 4.5 percent of GDP given capacity constraints and a more modest view of revenue mobilization.
- SNG budget execution rates averaged only about 60 percent in FY2018/19.
- Insufficient data on SNG operations; financial reporting system yet to be implemented.

Policy recommendations (paragraphs 34–37)
- Adopt a neutral fiscal stance to contain external and domestic pressures and keep debt on a sustainable path.
- Limit overall deficits to levels that keep debt on a sustainable path; avoid stoking domestic demand and balance-of-payments pressures in the near term.
- Anchor budget formulation at central and subnational levels in a medium-term fiscal framework (MTFF) that is not overly ambitious; use a top-down budget process and MTFF based on conservative revenue and expenditure assumptions.
- Consider creating and empowering a macro-fiscal unit to support MTFF and budget formulation through macroeconomic and fiscal forecasting, including sensitivity analysis.
- Align the overall SNG expenditure envelope with available funding; set tight limits on any subnational borrowing.
- Urgently develop a robust reporting and monitoring system for SNGs and clearly delineate roles and responsibilities across levels of government for service delivery and investment-project management.
- Strengthen public financial management (PFM) and budget implementation across levels of government; continue to strengthen procurement processes, train SNG staff, and ensure adequate controls and accountability.
- Devote more resources to the Public Procurement Monitoring Office (PPMO) to hire staff with expertise in procurement and contract monitoring; ministries responsible for public construction contracts should more actively track project execution and contractor performance.

Authorities’ views (paragraph 38)
- Authorities view a central government deficit outcome of around 5 percent of GDP as prudent.
- Recognized import growth this fiscal year has been lower than expected, implying likely underperformance of associated revenues; expenditure will be closely managed.
- Progress has been made in establishing the legal framework for fiscal federalism; measures implemented to strengthen capital-spending execution rates, including a project bank overseen by the National Planning Commission and an action room in the Prime Minister’s office for monitoring major projects.

Key figures and execution indicators cited
- Government expenditure budgeted to be 8 percentage points of GDP higher than last year’s outcome.
- Central government deficit: budgeted full execution outcome of 8.3 percent of GDP; staff projection of 4.5 percent of GDP.
- SNG budget execution rates: averaged about 60 percent in FY2018/19.
- Execution rates charts and capital-expenditure execution profiles cited in text figures (no additional numeric elaboration provided beyond percentages above).

### Structural reforms, investment climate, and climate vulnerability
Findings
- Reform efforts and improvements in political stability and electricity supply have helped the investment climate; 2020 World Bank Doing Business Report shows improvement, though longer-term gains are more modest.
- Improvements highlighted: Integrated Check Post at the Nepal-India border; expanded coverage of the Credit Information Bureau.
- Growth constrained by insufficient infrastructure investment and anemic foreign direct investment (FDI).
- Nepal is experiencing a demographic dividend: working-age population expected to continue growing strongly through about 2025.
- Gaps exist in size and quality of infrastructure network; process for obtaining investment-project permits is cumbersome and sometimes unclear across ministries and levels of government.
- Perceptions-based indicators suggest corruption is a significant problem; weaknesses in public procurement contribute to project under-execution.
- Nepal contributed 0.09 percent of global greenhouse gas emissions (2012), but is highly vulnerable to climate change—rising temperatures and extreme weather will increase flooding, landslides, and variation in meltwater flow affecting hydropower and agriculture.

Policy recommendations (paragraphs 43–46)
- Reduce the very high foreign-investor threshold of 500,000 USD in the revised FITTA to attract FDI to small and medium-sized enterprises.
- Streamline approvals process and clarify demarcation of responsibilities between levels of government under fiscal federalism.
- Improve implementation capacity in responsible ministries by ensuring adequate staffing, better skills matching, and aligned incentives.
- Strengthen public procurement enforcement and monitoring: provide more resources to PPMO and require ministries to maintain data on projects underway and contractor past performance.
- Factor climate-change mitigation and adaptation into the medium-term economic framework: pursue low-carbon development, continue emphasis on hydropower and e-mobility guidance (tax exemptions for electric vehicles).
- Build fiscal space and reserve buffers to respond to extreme weather events; adhere to disaster-proof building codes.
- Recognize substantial resource needs for fiscal buffers in a developing-country context and rely on foreign-grant support to help meet them.

Specific legislative and process notes
- Nepal’s AML/CFT National Strategy and Action Plan launched in August 2019; progress on addressing highest priority deficiencies, including legislation to clarify penalties for financing of terrorism, but changes not yet passed into law.
- Recent procurement reforms: reduction in up-front project mobilization grant size, more stringent scrutiny of bidders’ capacity, introduction of a project pipeline—enforcement and monitoring remain critical.

*Source: Annex V takes stock of 2014 FSAP recommendations (1nplea2020001).*

### 47.      The authorities underscored their commitment to improving the investment climate in

### 47. The authorities underscored their commitment to improving the investment climate in Nepal

### Investment climate and FDI
- Authorities highlighted amendments to FITTA and the new PPPI Act as supporting efforts to attract FDI and boost private sector investment.
- The Nepal Investment Summit generated many prospective project agreements and concrete spending commitments.
- Several transportation infrastructure (road, rail) projects are expected to get underway by the end of FY2019/20.
- Ongoing efforts to improve tax administration and public financial management are enhancing transparency and governance.

### Strengthening statistics and capacity building
- The ongoing rebasing of national accounts to the new 2010/11 base year (from 2000/01) is necessary for SNA2008 compliance.
- The rebasing exercise is expected to result in changes in the composition of GDP, and less so in the GDP level given the scarcity of new information sources.
- Another GDP rebasing is advisable once new census and survey information is available.
- Forthcoming dissemination of BOP data according to the BPM6 framework and other data-quality improvements are expected to help reduce large errors and omissions.
- Fund capacity development and surveillance delivery:
  - Technical assistance and training provided by HQ, SARTTAC, and the Singapore Training Institute, plus an MCM long-term financial sector expert based in Kathmandu.
  - Capacity development priorities: (i) financial sector supervision and regulation; (ii) monetary policy framework; (iii) fiscal federalism; (iv) public financial management; and (v) statistics issues on national accounts, government finance statistics, and the external sector.
  - To improve capacity building, less frequent rotation of NRB staff is warranted and officials nominated for training should have job responsibilities aligned with the proposed course.

### Macroeconomic outlook and key statistics
- Growth for FY2019/20 is expected to ease to 6 percent because of slower growth in India, sluggish remittance inflows, and weaker agricultural production.
- Inflation is expected at 6 percent due to high food inflation.
- In the context of moderating growth, there has been a narrowing of the current account deficit and stabilization of gross official reserves.
- Credit growth has moderated from very high levels, though credit as a share of GDP remains elevated relative to peers.
- Nepal’s external position in FY2018/19 is assessed as weaker than the level consistent with fundamentals and desirable policy settings.
- Downside risks include renewed balance of payments pressures and increased financial-sector risks if credit growth were to increase sharply or remittances slow down abruptly.

### Financial-sector risks and macroprudential policy
- The NRB has implemented macroprudential measures to limit the buildup of systemic risk.
- Actions to strengthen bank supervision and regulation include introduction of a supervisory information system and implementation of selected elements of the Basel III capital framework.
- Recent regulatory requirement: banks must cross-check corporate borrowers’ financial information against the ITS to facilitate more prudent risk assessment.
- Activation of the countercyclical capital buffer that will require banks to increase their level of capital by July 2020 is appropriate.
- Recommendation: NRB should continue to closely monitor asset quality of banks and improve monitoring of concentration risk.

### Fiscal policy and fiscal federalism
- Fiscal policy should be geared towards containing external pressures and protecting fiscal sustainability.
- A fiscal deficit of 4.5 percent of GDP, similar to the outcome in FY2018/19, would be prudent.
- Recent upgrades to tax administration are commended.
- Staff underscores that a top-down budget process and MTFF based on conservative revenue and expenditure assumptions would instill greater prioritization and avoid creating unrealistic revenue expectations among SNGs.
- Further efforts are needed to ensure spending is of high quality and executed in a timely manner.
- Transition to fiscal federalism:
  - The transition is a monumental challenge and needs careful management.
  - Overall expenditure envelope of SNGs needs to be aligned with available funding, with tight limits on any subnational borrowing.
  - A robust reporting and monitoring system for SNGs is urgently needed.
  - A clear delineation of roles and responsibilities across levels of government is required to ensure adequate delivery of services and investments.

### Monetary policy implementation and NRB governance
- Strengthening monetary policy implementation requires a well-functioning interest rate framework that reduces volatility in short-term interest rates.
- Less short-term interest rate volatility would support financial market development and improve policy signaling and transmission.
- Staff emphasizes introducing a standing deposit facility as a first step towards establishing a reliable implementation track record for the interest rate corridor.
- Achieving the central bank’s mandated price and financial stability objectives calls for modernizing the NRB governance framework to improve its autonomy and accountability.
- Reforms needed: strengthen independent oversight, safeguard institutional and personal autonomy, enhance internal controls and quality of external audit, and underpin these with supportive human resource management.

### Structural reforms to boost growth prospects
- To boost growth prospects, structural reforms that encourage high-quality investment projects, in particular FDI, are critical.
- As post-earthquake reconstruction spending draws to a close, maintaining recent growth momentum will require an enabling implementation environment for infrastructure projects and FDI.
- To ensure high-quality projects move forward in a clear and timely manner, authorities are encouraged to focus on:
  - adequate staffing;
  - better skills matching; and
  - aligning incentives across and within government ministries responsible for project approvals, implementation, and subsequent monitoring.

*STAFF APPRAISAL (excerpt).*

### 57.      It is proposed that the next Article IV consultation takes place on the standard

### 1nplea2020001 - 57. It is proposed that the next Article IV consultation takes place on the standard 12-month cycle.

### Recent Macro-Economic Developments
- Growth remained strong in FY2018/19 supported by the pick-up in the agriculture sector; the service sector remains a key driver for growth.
- On the expenditure side, growth was supported by stronger consumption expenditure.
- Headline inflation was to 6.5 percent (y/y) in December.
- The REER appreciated by 3.3 percent in Nov. 2019 (y/y).
- The current account deficit has narrowed in recent months, due in part to lower imports of fuel and construction material.
- Gross official reserves have stabilized at around US$8.7 billion, covering about 6.9 months of prospective imports of goods and services.

Key indicators (as presented in figures and text)
- Headline CPI (y/y): 6.5 percent (December; noted in text)
- REER appreciation: 3.3 percent (Nov. 2019, y/y)
- Gross official reserves: around US$8.7 billion; coverage: about 6.9 months

### Monetary Sector Developments
- Broad money expanded by 14.1 percent (y/y) in December, driven mostly by private sector credit growth.
- Deposit growth was 15.7 percent (y/y) in December.
- Private sector credit growth slowed to 14.8 percent in December (y/y).
- The credit-to-GDP ratio in Nepal is among the highest in its peer group.
- Short-term interest rates showed large volatility in FY2018/19, while deposit and lending rates remained stable.
- The deposit interest rate is near zero in real terms.

Selected monetary magnitudes and growth rates (from tables/figures)
- Broad money growth (Dec): 14.1 percent (y/y; figure caption)
- Deposit growth (Dec): 15.7 percent (y/y; figure caption)
- Private sector credit growth (Dec): 14.8 percent (y/y; figure caption)
- Table 3 (Reserve Money and Monetary Survey): Broad money (2019/20) 4,054 (in billions of Nepalese rupees, end-period); twelve-month percent change broad money: 13.2 (2019/20)
- Table 3: Reserve money levels (2019/20) 703 (in billions of Nepalese rupees)

### External Sector Developments
- The current account deficit was about 8 percent of GDP for the last two consecutive years.
- The trade balance has been improving recently as import growth has declined.
- The total number of foreign workers (new and renewals) grew by 16.4 percent in December (y/y, 3mma).
- Growth of remittances has slowed in recent months.
- Attracting FDI flows has been a struggle; exports contribute little to GDP and their role has been decreasing over time.

Selected external sector figures and trends
- Current account deficit: about 8 percent of GDP (last two consecutive years; figure caption)
- Total foreign workers growth: 16.4 percent (December, y/y, 3mma)
- Remittances (2018/19): US$7,769 million (Table 2)
- Remittances (2019/20): US$8,402 million (Table 2)
- Remittances (in percent of GDP): 26.0 (2016/17), 24.9 (2017/18), 25.3 (2018/19), 24.7 (2019/20) — Table 2 / Table 1
- Exports, f.o.b. (2018/19): 1,002 (in millions of U.S. dollars); Imports, f.o.b. (2018/19): -12,375 (in millions of U.S. dollars) — Table 2

### Fiscal Developments
- In FY2018/19, the fiscal deficit was 4.6 percent of GDP compared to 6.7 percent of GDP in FY2017/18.
- Public debt remained flat at 30 percent of GDP in 2018/19.
- In FY2018/19, the chief source of revenue was VAT (7.0 percent of GDP), followed by income tax revenue and customs.
- Expenditure grants were the biggest component of spending in FY2018/19, followed by capital expenditure.
- Tax collections relating to imports comprise nearly half of total tax revenues.
- Capital expenditure was 7 percent of GDP in 2018/19.

Key fiscal numbers (from tables)
- Fiscal deficit (central government net lending/borrowing):
  - 2017/18: -6.7 (percent of GDP)
  - 2018/19: -4.6 (percent of GDP)
- Public debt:
  - 2017/18: 30.2 (percent of GDP)
  - 2018/19: 30.1 (percent of GDP)
- VAT (2018/19): 7.0 percent of GDP (figure caption)
- Capital expenditure (2018/19): 7 percent of GDP (figure caption)
- Table 1 (Selected Social and Economic Indicators):
  - Total revenue and grants (2018/19): 26.0 (percent of GDP)
  - Expenditure (2018/19): 30.6 (percent of GDP)
  - Net lending/borrowing (2018/19): -4.6 (percent of GDP)

### Cross-Country Fiscal and Socio-Economic Context
- Nepal’s stock of public debt is modest relative to peers: 30 percent of GDP (2018/19).
- Relative to peer countries, Nepal’s public expenditure is high.
- Thanks to its low stock of debt and relatively low interest rates, Nepal’s interest expense is modest.
- Gross debt is considerably lower than in peer countries; Nepal remains at low risk of debt distress (reference in figure caption).
- Nepal is among the lowest income countries in South Asia.
- Poverty has fallen significantly in the last decade; improvements are reflected in UNDP Human Development Index gains.
- Expected human capital development is somewhat hampered by incomplete education and health factors.
- Substantial gains have been made in sanitation, though there is scope for further improvement.
- Global Hunger Index and Human Capital Index indicators show areas for progress (figures).

Representative cross-country socio-economic figures (from figures)
- Per Capita GDP (PPP) comparisons: Nepal is near the lower end among listed South Asian countries (figure)
- Human Development Index (HDI, 2017): Nepal included among lower-ranked countries in the regional set (figure)
- Human Capital Index (2018): Nepal shown below many peers (figure)
- Global Hunger Index rank for Nepal: presented as (73) in the figure caption for 2019 ranking

### Projections and Key Forecasts (Table highlights)
- Real GDP (annual percent change), projections:
  - 2019/20: 6.0
  - 2020/21: 5.7
  - 2021/22: 5.5
  - 2022/23: 5.4
  - 2023/24: 5.3
  - 2024/25: 5.3
- Headline CPI (period average), projections:
  - 2019/20: 6.0
  - 2020/21: 5.9
  - 2021/22: 5.8
  - 2022/23: 5.6
  - 2023/24: 5.3
  - 2024/25: 5.3
- Current account (in percent of GDP), projections:
  - 2019/20: -5.2
  - 2020/21: -4.9
  - 2021/22: -4.8
  - 2022/23: -4.7
  - 2023/24: -4.6
  - 2024/25: -4.4
- Gross official reserves (in millions of U.S. dollars), selected years:
  - 2016/17: 9,264
  - 2017/18: 9,304
  - 2018/19: 8,545
  - 2019/20: 8,536
  - 2024/25 projection: 7,673 (Table 1 / Table 2)
- Public debt (in percent of GDP), projections shown in Table 1:
  - 2018/19: 30.1
  - 2019/20: 33.7
  - 2020/21: 35.7
  - 2021/22: 37.4
  - 2022/23: 39.0
  - 2023/24: 40.3
  - 2024/25: 41.1

### Financial Soundness (selected indicators, Table 5)
- Capital adequacy (2018/19):
  - Capital to risk weighted assets: 14.1 (percent)
  - Tier 1 capital to risk weighted assets: 12.8 (percent)
- Asset quality (2018/19):
  - NPLs to total loans: 1.3 (percent)
  - Loan loss provision to total loans: 1.9 (percent)
- Profitability (2018/19):
  - Return on equity (ROE): 15.0 (percent)
  - Return on assets (ROA): 1.6 (percent)
- Liquidity (2018/19):
  - Liquid assets to total assets: 18.4 (percent)
  - Liquid assets to total deposits: 22.8 (percent)
- Exposure to real estate (2018/19):
  - Share of real estate and housing loans: 13.4 (percent)
  - Share of loans collateralized by land and buildings: 59.7 (percent)

*Source: Nepalese authorities; and IMF staff estimates and projections (as presented in the provided content).*

### Annex I. External Sector Assessment

### Annex I. External Sector Assessment

### Overall assessment
- Nepal’s external position in 2018/19 is assessed to be weaker than the level consistent with medium-term fundamentals and desirable policy settings.
- Nepal’s large current account deficit reflects high imports due to earthquake reconstruction and strong domestic demand.
- The current level of foreign reserves is assessed to be adequate and the net international investment position is stronger than in regional peers, supporting the peg to the Indian rupee.
- Prudent macroeconomic policies are advised to safeguard medium-term external sustainability.

### International Investment Position (IIP)
- Nepal’s net IIP stood at US$1.4 billion (4.8 percent of GDP) as at mid-July 2019.
- Central bank reserve assets exceed public external debt.
- External liabilities related to foreign direct investment (FDI) are rather small owing to Nepal’s weak business climate which has held back private investment.
- There has been a sharp decline in Nepal’s IIP over the last two fiscal years (a 65 percent decrease). A continuation of this trend, combined with higher FDI as the business climate improves, could bring Nepal’s net IIP to negative territory.
- At present Nepal is a net creditor; therefore there are no immediate sustainability concerns.

### Current account, EBA-lite model results, and REER
- The current account deficit was 7.7 percent of GDP in FY2018/19; remittances were a quarter of GDP and helped finance the large trade deficit.
- The EBA-lite current account model indicates Nepal’s current account is weaker than the current account norm:
  - Current account norm: a deficit of 3.8 percent of GDP in FY2018/19.
  - Model indicates a CA-gap of between -2.8 to -4.8 percent of GDP.
  - Assuming an elasticity of the trade balance with respect to changes in the REER of -0.18, this indicates that the REER would need to depreciate between 15 to 27 percent to close the current account gap.
- The EBA-lite IREER model indicates Nepal’s REER is overvalued compared to the equilibrium REER:
  - By mid-July 2019, Nepal’s REER is estimated to be 21 percent more appreciated than the equilibrium REER derived from a panel regression for 126 countries.
  - Reported REER gap values: REER gap21.8%, ln(REER) actual4.67, Ln(REER) norm4.46, REER gap20.9%.
- Large positive net errors and omissions suggest that the current account deficit and the REER gaps are likely overestimated; positive net errors and omissions amounted to 2.7 percent of GDP in FY 2018/19.

### Drivers of the external gap and policy implications
- EBA-lite attribution of the current account gap (-3.8 percent of GDP):
  - Estimated policy gap: -2.6 percent of GDP (70 percent of CA-gap).
  - Other gap (residual): -1.1 percent of GDP (30 percent of CA-gap).
- This attribution suggests prudent monetary and financial policies would help safeguard Nepal’s medium-term external sustainability.
- Competitiveness is affected by structural impediments in addition to real exchange rate appreciation:
  - Nepal is landlocked and relies heavily on India for ground transportation; two-thirds of trade is with India and all oil imports are from India.
  - Trade treaty aspects: Nepal can settle trade with India in Indian rupees and FDI from India can be made in Indian rupees.
  - The peg to the Indian rupee reduces exchange rate uncertainty with its major trading partner, but real appreciation of the Nepali rupee against the Indian rupee can impact competitiveness.
  - Private investment and exports are held back by the infrastructure gap, red tape, and product and labor market frictions.

### Capital flows and foreign direct investment
- Capital flows consist mostly of concessional loans and trade credit.
- FDI comprised only 0.4 percent of GDP in FY2018/19, as a result of restrictions and complexity of the current approval system.
- Nepal’s capital account remains mostly closed; portfolio flows are negligible.
- In FY2018/19, official loans declined reflecting delays in project implementation. Trade credits fell slightly.

### Reserves and reserve adequacy
- Nepal’s central bank reserves fell to US$8.5 billion at mid-July 2019 from a peak of US$9.5 billion in mid-January 2018.
- The IMF’s tool for assessing reserve adequacy in credit-constrained economies (ARA-CC) suggests the current level of foreign exchange reserves—equivalent to about 7 months of prospective imports of goods and services and 28 percent of broad money—is adequate.
- Under the ARA-CC methodology, the estimate of the adequate level of reserves is 3.6 months of prospective imports of goods and services (using a cost of holding reserves of 6.2 percent and potential real GDP growth rate of 5 percent). Modifying the ARA metric to include a buffer given Nepal’s high vulnerability to natural disasters (lowering the growth rate by 2 percentage points to 3 percent) increases the adequate level of reserves to 4.2 months of prospective imports of goods and services.
- Reserves have been stabilizing in recent months, thanks in part to greater domestic electricity and cement production.
- Gross official reserve coverage is expected to decline to 4.3 months of prospective imports by FY2024/25.

### Risks, expected impacts, and recommended policy actions (selected)
- Large swings in energy prices (External; H; ST, MT): Mixed effects on current account and inflation; recommendation: continue developing hydroelectric capacity; tighten stance of fiscal policy.
- Rising protectionism and retreat from multilateralism (External; H; ST, MT; L likelihood): Potential slowdown in global activity could affect trading partners; recommendation: maintain sound policy frameworks; improve the investment climate to reduce dependence on remittances.
- Cyber-attacks (External; L likelihood; ST, MT; M–H impact): NRB vulnerabilities identified; recommendation: enhance NRB IT capacity as part of broader NRB capacity strengthening.
- Excessively expansionary monetary policy (Domestic; M likelihood; ST, MT; H impact): Could increase BOP pressures and financial sector risks; recommendation: tighten macroprudential policies to contain credit growth.
- Financial sector vulnerabilities exposed by waning remittances (Domestic; M likelihood; ST, MT; H impact): Slower deposit growth could affect liquidity and loan-portfolio weaknesses; recommendation: exercise supervisory, corrective, and sanctioning powers more forcefully, including through more pro-active risk-based supervision.
- Weaker-than-expected growth in India and GCC countries (External; H likelihood; ST, MT; H impact): Could reduce remittances, FDI and exports; recommendation: accelerate structural reforms to improve the investment climate and boost public investment.
- Higher frequency and severity of natural disaster and climate change (Domestic; L–M likelihood; ST, MT; H impact): Nepal highly vulnerable to natural disasters; recommendation: adhere to disaster-proof building codes; build fiscal space and reserve buffers; enhance financial safety nets.

### Implications for the exchange rate peg and macro framework
- Nepal’s net creditor position and adequate reserves support the peg to the Indian rupee.
- The EBA-lite results point to a significant role for domestic monetary/financial policies in addressing the current account gap; maintaining prudent macroeconomic policies and addressing structural constraints (infrastructure, red tape, product and labor market frictions) are central to improving external sustainability and competitiveness.

*Source: Annex I. External Sector Assessment (extracted from the supplied IMF content).*

### Annex V. Progress in Implementing High-Priority

### Annex V. Progress in Implementing High-Priority Recommendations in the 2014 FSAP

### Financial Stability
- 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 to date: Not done  
  - Note: The interest rate corridor (IRC) is not serving as an effective policy tool. Deficiencies in the IRC framework—including lack of a standing deposit collection facility—have resulted in highly volatile short-term rates that often fall below the IRC floor.
- 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*: Short term (ST)  
  - Progress to date: Fully Implemented
- Recommendation: Conduct an in-depth review and financial analysis of loan portfolios during bank examinations.  
  - Responsible Authority: NRB  
  - Time Line*: Short term/Medium term (ST/MT)  
  - Progress to date: In process  
  - Note: Loan portfolio reviews are performed on a regular basis during on-site inspections by the Supervision department of the NRB. The quality of reviews should be enhanced by the launching of Supervisory Information System (SIS).
- 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*: Short term/Medium term (ST/MT)  
  - Progress to date: In process  
  - Progress details:  
    - 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 (RTGS) is in full operation since November 22, 2019 in commercial banks.  
    - 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.  
    - The Credit Information Bureau has expanded its coverage.  
    - Limited progress has been made regarding the strengthening of 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*: Short term/Medium term (ST/MT)  
  - Progress to date: In process  
  - Progress details:  
    - 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.  
    - The pilot Supervisory Information System (SIS) was launched on January 8, 2020.  
    - 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; and by proactive, earlier, and stronger corrective actions.  
  - Responsible Authority: NRB  
  - Time Line*: Medium term (MT)  
  - Progress to date: In process  
  - Progress details: 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*: Medium term (MT)  
  - Progress to date: 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*: Medium term (MT)  
  - Progress to date: In progress  
  - Progress details: The Bank and Financial Institutions Act (BAFIA), 2016 has defined the term "Related Party" and "Controlling Interest". However, neither the BAFIA nor the NRB Act has assigned explicit powers to NRB for consolidated supervision of bank and financial institutions including their related parties and entities with controlling interest.

### 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*: Short term (ST)  
  - Progress to date: 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*: Medium term (MT)  
  - Progress to date: Not done
- Recommendation: Strengthen the operational independence of the IB and SEBON.  
  - Responsible Authority: SEBON/IB/MOF  
  - Time Line*: Short term (ST)  
  - Progress to date: Not done

### 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*: Short term (ST)  
  - Progress to date: Fully implemented
- 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*: Medium term (MT)  
  - Progress to date: In process  
  - Progress details: 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*: Short term (ST)  
  - Progress to date: Done  
  - Progress details: NRB Act has been amended with the revision in provision related to refinancing and lender of last resort in section 49. Previously, refinancing and lender of last resort facilities had been available for 6 months and could be renewed for another 6 months only, however, with the amendment, the tenure has been extended to 1 year for both the facilities.
- Recommendation: Revise NRB Act to grant it special resolution regime powers.  
  - Responsible Authority: NRB/MOF  
  - Time Line*: Short term (ST)  
  - Progress to date: Fully implemented
- 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*: Short term/Medium term (ST/MT)  
  - Progress to date: Done  
  - Progress details: Crisis Management Co-ordination Committee has been formed with the conveyorship of the Deputy Governor, including representative from the Ministry of Finance, the Securities Exchange Board of Nepal, and the Insurance Board.
- Recommendation: Crisis simulations should be conducted periodically.  
  - Responsible Authority: MOF/NRB/IB/SEBON  
  - Time Line*: Medium term (MT)  
  - Progress to date: Not done

*Time Line as presented in source.

*Annex V. Progress in Implementing High-Priority Recommendations in the 2014 FSAP — Source document.*

### Annex VI. Staff Policy Advice from the 2017 and 2018 Article IV

### Annex VI. Staff Policy Advice from the 2017 and 2018 Article IV

### Fiscal Policy
- Policy advice:
  - Care should be taken not to exceed the economy’s aggregate absorptive capacity and to safeguard expenditure quality (2017).
  - Staff recommended more front-loaded fiscal consolidation and an improved composition of expenditure in the medium-term (2018).
  - Expansion of government spending should be anchored in a medium-term expenditure framework (2017).
  - A comprehensive assessment of the resources needed by subnational governments to deliver on their expenditure mandates set out in the Constitution should be conducted expediently (2018).
  - Budget preparation and implementation capacity should be strengthened, with a more realistic initial assessment and capital spending spread more evenly throughout the fiscal year (2017/18).
  - Continued improvements in revenue performance will be important, including efforts to strengthen customs administration (2017/18).

- Policy actions and outcomes:
  - In FY2018/19, the central government deficit is estimated to have narrowed to 4.5 percent of GDP (from 6.7 percent of GDP in FY2017/18).
  - Authorities have undertaken substantial measures to strengthen customs administration, including reforms to customs valuation and adoption of risk-based customs clearance and an e-payment system.
  - The Department of Customs is implementing ASYCUDA World and risk-based custom clearance to incentivize traders with good track record with faster compliance.
  - Budget remains ambitious, and capital spending is typically backloaded in the fiscal year.
  - Measures to strengthen capital-spending execution rates and smooth its annual profile include: adoption of a project pipeline overseen by the National Planning Commission, and an action room in the Prime Minister’s office for monitoring progress on major projects.
  - Progress on assessing subnational government spending needs: workstream led by the World Bank; Federalism Capacity Needs Assessment provides a broad framework; work ongoing to assess fiscal gap between expenditure needs and revenue capacity at the SNG level; assessment of duplication of responsibilities and spending across government levels is underway.

### Monetary, Exchange Rate, and Financial Policies
- Policy advice:
  - The interest rate corridor should be complemented by a binding interest rate floor, set at a level close to current market conditions, with periodic NRB review and potential gradual narrowing of the corridor to contain interbank rate volatility (2017). (2018) The corridor itself should be adjusted to better align short-term nominal interest rates in Nepal with those in India.
  - The NRB should resume using its IRC, actively mopping up excess liquidity when needed, bringing interbank rates back towards the mid-point of the target range (2018).
  - Consideration should be given to phase out NRB requirements for directed lending by commercial banks (2017).
  - Regulatory and macro-prudential measures should be maintained to contain the buildup of financial sector risks, and the relief to banks with regard to the 80 percent loan-to-deposit ratio ceiling should be withdrawn (2017).
  - The monetary policy stance needs to be tightened to rein in imbalances and support the exchange rate peg. The NRB should adopt a medium-term inflation objective consistent with eliminating the inflation wedge with India (2017).
  - Communication regarding the quarterly reviews conducted by the NRB should be enhanced and used to assess and explain the appropriateness of the policy stance (2018).
  - In the context of the recently initiated review of the NRB Act, staff recommends amendments to strengthen the central bank’s operational autonomy (2018).
  - To ensure credit growth slows to a sustainable pace, macro-prudential measures should be tightened (2017/18).
  - Given data and supervisory weaknesses and the cyclical position, banks should build additional capital and provisioning buffers against potential losses (2018).
  - Staff recommends introduction of a directive to govern practices related to revolving lending, including working capital loans; introduce a clean-up period for revolving loans to curb ever-greening (2018).
  - On the regulatory front, the central bank’s lender of last resort policy, last updated in 2011, needs to be further clarified and aligned with standard central bank practices with respect to emergency liquidity assistance (2018).
  - Staff welcomes plan to establish a supervisory mechanism for financial cooperatives.

- Policy actions and outcomes:
  - The NRB narrowed the width of the corridor by 1 percentage point in July 2018. However, it continues to lack a binding floor and liquidity absorption remains fully at the NRB’s discretion.
  - The provision for banks to extend at least 25 percent of their total lending to priority sectors remains in effect to channel resources into agriculture, energy, tourism and small and medium enterprises (no change of policy action reported).
  - The NRB maintains macroprudential measures such as credit-to-core capital and deposit ratio, loan-to-value ratio, and sectoral limits on banks’ exposure.
  - NRB introduced debt service-to-income ratio and a countercyclical capital buffer of 2 percent to be met by July 2020.
  - In August 2019, the NRB removed interbank borrowing from the CCD ratio calculation.
  - Since late 2018, the credit-to-core capital and deposit (CCD) ratio became binding for most banks and the NRB reduced the limit on personal overdraft loans.
  - Recent NRB actions include requirement to cross-check borrower financial information against the Integrated Tax System and requirement to cross-check reported net tradable assets with tax reports (likely to control working capital loans).
  - SIS (Supervisory Information System) launched and expected to enhance NRB’s off-site supervision.
  - A consultant has been hired to draft LOLR policy and the draft is in the progress of being finalized.
  - Regarding NRB Act review, a recently proposed amendment, currently tabled in the Parliament, maintains the provision that allows the government to issue directives to the central bank related to currency, banking and finance, and allow dismissal of the governor, deputy governor, and the board of directors if instructions are not followed; it introduced an additional ground for dismissal: causing unnecessary delay in work performance of the Bank.
  - Authorities are encouraging merging of cooperatives to facilitate more effective supervision of cooperatives. Depending on cooperatives’ territory of activity, corresponding government authority—municipal, province and federal—monitors and supervises the cooperatives.

- Analytical observations:
  - In the context of less developed financial markets and very weak pass-through from the policy rate to market rates, macroprudential policies have proven more effective than the interest rate as a policy tool by directly affecting the supply of credit.
  - Macroprudential measures have been playing a critical role in containing credit growth.
  - Banks have not built additional buffers against losses; there are lingering gaps in measuring asset quality.
  - The authorities do not intend to introduce a clean-up period for working capital loans.

### Structural Policies
- Policy advice:
  - Improve business environment and address structural bottlenecks to stimulate private sector activity, encourage foreign direct investment, and boost job creation.
  - A single window should be offered to all investors, the Investment Board of Nepal Act should be strengthened, and public-private partnership policy should be amended.
  - Amendments to the Labor Bill and Foreign Investment and Technology Transfer Act (FITTA) are needed to enhance labor and product-market flexibility (2017/18).
  - Efforts are needed to strengthen institutions and reduce corruption. The Public Procurement Act should be strengthened, extending the scope of misconduct which can be pursued as corruption by the Commission for the Investigation of the Abuse of Authority (CIAA) (2018).

- Policy actions and outcomes:
  - The new FITTA (2019), which supersedes the Investment Board of Nepal Act, includes:
    - a broader definition of what constitutes foreign investment, and a foreign investor;
    - Investment Board of Nepal to approve projects above 6 billion rupees;
    - a shortened approval timeline (from 30 to 7 days);
    - a one-stop service center to facilitate foreign investors obtaining necessary visas and some other documentation; and
    - scope for some assistance with land procurement.
  - The Public-Private-Partnership Act is in the process of being revised, but legislation has not yet been passed into law.
  - Several public-procurement regulations have been issued, including a reduction in the ‘mobilization’ payment paid to contractors (from 20 to 10 percent), and improvements to the evaluation of bidding contractors’ capacity to deliver.
  - Changes to the Public Procurement Act are in progress, but have not yet been passed into legislation by parliament.
  - The CIAA has played an active role in bringing cases against parties accused of misconduct.

### Fund Relations, Technical Assistance, and Data/Statistical Issues
- Fund relations (as of December 31, 2019):
  - Membership Status: Joined September 6, 1961; accepted Article VIII, Sections 2, 3, and 4 on May 30, 1994.
  - General Resources Account:
    - 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: 1.36 SDR Million, 2.00 percent
  - Outstanding Purchases and Loans:
    - RCF Loans: 38.50 SDR Million, 24.54 percent of quota
  - Financial Arrangements (In SDR Million) — Approved and Drawn (historic):
    - ECF 11/19/03–11/18/07: Amount Approved 49.90, Amount Drawn 49.90
    - ECF 10/05/92–10/04/95: Amount Approved 33.57, Amount Drawn 16.79
    - SAF 10/14/87–10/13/90: Amount Approved 26.11, Amount Drawn 26.11
  - Projected Obligations to Fund (in millions of SDRs):
    - Principal: 2020: 2.85; 2021: 7.13; 2022: 7.13; 2023: 7.13; 2024: 7.13
    - Charges/interest: 2020: 0.50; 2021: 0.49; 2022: 0.49; 2023: 0.49; 2024: 0.50
    - Total: 2020: 3.35; 2021: 7.62; 2022: 7.62; 2023: 7.62; 2024: 7.63
  - Exchange rate arrangement: conventional peg to a single currency unit; Nepalese rupee pegged to the Indian rupee at a rate of NRs 1.6 per Indian rupee. As of January 30, 2020, exchange rate: US$1 = Nrs. 114.2.
  - Industrial Enterprises Act: places a 75 percent limit on the conversion and transfer to foreign currency of salaries of non-residents from countries where convertible currency is in circulation (gives rise to an exchange restriction under Article VIII).

- Safeguards assessment:
  - An update safeguards assessment of the NRB completed February 2016 (with respect to Rapid Credit Facility approved July 31, 2015) found limited progress in improving safeguards and that the quality of external audit continued to fall short of international standards.
  - A safeguards monitoring mission in May 2018 found implementation of recommendations from the 2016 assessment to be limited; progress continues to be slow with several priority recommendations outstanding.
  - Key areas needing strengthening: NRB autonomy and governance via central bank legal framework amendments, external audit, internal controls.
  - Staff is providing technical assistance to strengthen internal audit; NRB is establishing an information security unit and updating lender of last resort regulation.
  - Progress hampered by human resources policy, which NRB is reviewing.

- Technical assistance (since 2018 Article IV Consultation) — Purpose and Year:
  - MCM: Strengthening Internal Audit 2018; Cyber Security 2018
  - SARTTAC: Financial Supervision and Regulation 2018/2019
  - Strengthening Fiscal Reporting 2018
  - Government Finance Statistics and Public Sector Debt Statistics Training 2018/2019
  - STA: Price Statistics Training 2018; National Accounts Training 2019; Liquidity Monitoring and Forecast Tool 2019; External Sector Statistics 2019; Fiscal federalism workshop 2020; Monetary and Financial Statistics 2019; External Sector Statistics 2019

- Resident Representative:
  - Mr. Luis Breuer has been the Senior Resident Representative since July 26, 2019. He is based in New Delhi.

- Statistical issues and data adequacy (As of January 2020):
  - General: Economic and financial data are broadly adequate for surveillance, with scope for improvement especially in updating the base year of the national account, more detailed price statistics, and timeliness and quality of balance of payments data.
  - National accounts:
    - CBS compiles national accounts using the 1993 SNA standard.
    - Plans in 2020 to release a major revision to be SNA2008 compliant and update base year for constant price measures from 2000/01 to 2010/11; rebasing supported by World Bank.
  - Price statistics:
    - NRB compiles CPI. New CPI series with 2014/15 base year released October 2015 (previous base year 2005/06).
    - WPI published by NRB with weights based on 1999/2000; coverage: agricultural commodities (49.6 percent), domestic manufactured goods (20.4 percent), and imported goods (30 percent).
    - PPI coverage currently restricted to manufacturing; CBS received TA to update and expand PPI.
    - Index of wages and salaries compiled with base year 2004/05.
  - Government Finance Statistics:
    - Fiscal data for budgetary central government compiled in accordance with GFSM 2001 since 2011 and adopting GFSM 2014 with SARTTAC support.
    - Areas needing improvement: exclude financing transactions from functional classification of expenditure; clearer COA distinction between revenue and expense and transactions in nonfinancial assets; clarify classification of transfers; compilation of below-the-line financing transactions; development of government financial balance sheet.
  - Monetary and Financial Statistics:
    - NRB reports SRFs 1SR, 2SR, and 5SR monthly to IFS with about one month lag.
    - Coverage expanded to include development banks and finance companies; expanded broad money survey compiled and published.
    - Inconsistencies exist in reporting of positions between NRB and ODCs.
    - Monetary and financial statistics mission November 2019 assisted NRB to improve SRF compilation and expand SRF 2SR coverage to include microfinance institutions and savings and credit cooperatives.
    - NRB reports indicators to Financial Access Survey including commercial bank branches per 100,000 adults and ATMs per 100,000 adults.
  - Financial Soundness Indicators:
    - NRB reports 12 core FSIs and 8 of 13 encouraged FSIs for deposit takers, 2 FSIs for OFCs, 1 FSI for households, and 2 FSIs for real estate markets quarterly with about one quarter lag.
  - External Sector Statistics:
    - NRB compiles BOP statistics in conformity with BPM5; started reporting IIP data following BPM6 in February 2015.
    - Key shortcomings: (i) overestimation of imports of goods; (ii) underestimation of exports of travel services; (iii) inclusion of commercial banks’ assets in reserve assets; (iv) incompleteness of data on foreign grants; (v) potential under-coverage of external debt statistics.
    - Since 2012 NRB has received TA in ESS; 2019 STA mission reviewed preliminary BOP data per BPM6 and assisted in improving measurement of trade in goods and services, remittances, direct investment, trade credit, external debt statistics, and reserve assets.
    - Quality of BOP data has improved with IMF STA TA and training.

- Data dissemination and standards:
  - Nepal has implemented recommendations of enhanced General Data Dissemination System (e-GDDS). National Summary Data Page launched in June 2017.
  - Data ROSC on fiscal transparency published October 2007.

- Table of Common Indicators Required for Surveillance (As of January 31, 2020) — selected latest observation dates and frequency notes:
  - Exchange Rates: Date of latest observation 12/19; Date received 01/20; Frequency: Daily and Monthly; Frequency of Reporting: Weekly and Monthly; Frequency of Publication: Weekly and Monthly.
  - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: 12/19 observed; 01/20 received; Monthly frequency and reporting/publication.
  - Reserve/Base Money: 12/19 observed; 01/20 received; Monthly.
  - Broad Money: 12/19 observed; 01/20 received; Monthly.
  - Central Bank Balance Sheet: 12/19 observed; 01/20 received; Monthly.
  - Consolidated Balance Sheet of the Banking System: 12/19 observed; 01/20 received; Monthly.
  - Interest Rates: 12/19 observed; 01/20 received; Daily and Monthly frequency of observation; Weekly and Monthly reporting/publication.
  - Consumer Price Index: 12/19 observed; 01/20 received; Monthly.
  - Revenue, Expenditure, Balance and Composition of Financing – General Government: 12/19 observed; 01/20 received; Monthly.
  - GDP/GNP: 2018/19 observed; 08/19 received; Annual frequency.
  - Gross External Debt: 2018/19 observed; 08/19 received; Annual frequency.
  - International Investment Position: Q2/19 observed; 08/19 received; Quarterly frequency.

### Debt Sustainability Analysis (DSS)
- Findings:
  - Debt Sustainability Analysis using the joint IMF/WB Debt Sustainability Framework for Low Income Countries (LIC-DSF) shows Nepal remains at low risk of debt distress for both the external and overall public debt.
  - All debt and debt service indicators are projected to be well below their indicative threshold values under the baseline scenario as well as the stress tests.
  - Analysis indicates Nepal’s public debt is projected to gradually increase over the medium-term owing to continuing fiscal and current account deficits.
  - Debt sustainability is vulnerable to export and economic growth shocks.
- Policy implications:
  - Findings stress the importance of implementing reforms to increase the economy’s resilience to external shocks and to encourage diversification.
  - Further efforts to improve domestic productivity and competitiveness and to enhance monitoring of risks related to contingent liabilities are necessary to ensure medium- to long-term debt sustainability.

*Prepared by the staff of the International Monetary Fund and the International Development Association. February 27, 2020.*

### 1.      The coverage of public debt in this analysis includes central and local governments’ debts,

### 1nplea2020001 - 1.      The coverage of public debt in this analysis includes central and local governments’ debts,

### Coverage and scope
- Coverage includes central and local governments’ debts, government guarantees, and central bank borrowing.
- Nepal’s provincial and local governments had no debt; their borrowing framework is under consideration and should be monitored carefully.
- 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.
- Bond issuances by the central bank were only for the purpose of the monetary policy.
- State-owned enterprises (SOEs) borrow abroad through the central government and are therefore included in the coverage of central government debt.
- The government has recently started providing guarantees for debts of SOEs.

### Stock and composition of public debt (mid-2019 / end FY2018/19)
- Total public debt: 30.1 percent of GDP at mid-2019.
- Public debt path:
  - 25 percent of GDP in mid-2015 (prolonged decline).
  - 30.2 percent of GDP at mid-2018.
  - Stock for July 2019 stayed at almost the same level as the previous fiscal year.
- External public debt:
  - External public debt stood at 17 percent of GDP at mid-July 2019.
  - External debt-to-GDP ratio declined slightly by 0.4 percentage point since mid-2018.
  - Net present value (PV) of external debt: about 12.2 percent of GDP (high degree of concessionality).
  - Creditor composition: multilateral creditors account for 89 percent of all external debt.
  - Multilateral average interest rate: 1 percent on average.
  - Multilateral average maturity: 26 years on average.
  - Largest bilateral creditor: Japan, followed by China, India, and Korea.
- Domestic public debt:
  - Domestic public debt: 13.1 percent of GDP at mid-July 2019.
  - About 32 percent of domestic public debt is treasury bills with maturity up to 1 year (28-days, 91-days, 182-days, and 364-day treasury bills), of which about a half is 364-day bills.
  - Medium- to long-term debt comprises mostly development bonds with maturities of 3-15 years and interest rates of 3-6.5 percent per annum.
  - All domestic public debt was held by residents (currency-based analysis).
- Private external debt:
  - Stock not published by authorities but estimated to be very small.
  - Non-public sector foreign borrowing about 0.1 percent of GDP at mid-July 2019.
  - Private external debt is assumed to increase to 1 percent of GDP in the long term.

### Tabled figures (external public debt, end FY2018/19)
- Total external: 5,366 (In millions of US$s) — 17.0% of GDP — 100% of external debt.
- Multilateral: 4,760 — 15.1% of GDP — 89% of external debt.
  - AsDB: 1,826 — 5.8% of GDP — 34% of external debt.
  - IDA: 2,781 — 8.8% of GDP — 52% of external debt.
- Bilateral: 606 — 1.9% of GDP — 11% of external debt.
  - Paris Club: 319 — 1.0% of GDP — 6% of external debt.
  - Non-Paris Club: 287 — 0.9% of GDP — 5% of external debt.

### Tabled figures (public domestic debt, end FY2018/19)
- Total domestic: 453 (In billions of Nepalese rupees) — 13.1% of GDP — 100% of domestic debt.
- Treasury bills: 147 — 4.2% of GDP — 32% of domestic debt.
- Treasury bonds: 306 — 8.8% of GDP — 68% of domestic debt.
  - Development bonds: 297 — 8.6% of GDP — 66% of domestic debt.
  - Others: 9 — 0.3% of GDP — 2% of domestic debt.

### Contingent liabilities and other public sector exposures
- Contingent liability stress test includes:
  - SOE debt: 2 percent of GDP.
  - PPP projects: 2.1 percent of GDP.
  - Financial market: 5 percent of GDP.
- PPP contracts: PPI database estimates Nepal’s PPP contracts at about 6 percent of GDP as of 2017.
- Major SOEs:
  - Nepal Oil Corporation (NOC) and Nepal Electricity Authority (NEA).
  - NOC and NEA debt amounted to 3.3 percent of GDP as of July-2019; their debts are owed to the government and included in government debt.
- Government guarantees:
  - Government provided a guarantee to Nepal Airlines Corporation for the purchase of an airplane in FY2018/19, which is 1.0 percent of GDP.

### Macro forecasts and assumptions
- Growth:
  - Real GDP growth: 7.1 percent in FY2018/19 (up from 6.7 percent in previous fiscal year).
  - Mid- to long-term expected to converge to potential growth of 5.3 percent.
- Inflation:
  - Inflation rate: 4.6 percent annually in FY2018/19; rose to 6.0 percent at mid-July 2019 owing to a surge in food prices.
  - Expected to stabilize at 5.3 percent over the medium-term.
- External sector:
  - Current account deficit: 7.7 percent of GDP in FY2018/19.
  - Remittances: about a quarter of GDP.
  - Gross official reserves: US$8.5 billion in July 2019, from US$9.3 billion at end of previous fiscal year.
  - Large positive net errors and omissions in the balance of payments: 2.7 percent of GDP in FY2018/19.
  - External debt projections: decrease gradually to 18.5 percent of GDP at mid-2020 and 12 percent of GDP by mid-2040.
- Selected macro table excerpts (series and numbers preserved as in source):
  - Real growth (%) historical and projections row: 6.3 5.1 4.5 6.7 7.1 5.8 5.4 5.3 0.4 0.8
  - CPI (period average, %) row: 4.2 5.3 5.0 4.1 4.6 6.1 5.3 5.0 0.0 0.0
  - Current account balance (% GDP) row: -8.2 -7.2 -2.3 -8.1 -7.7 -5.2 -4.9 -4.0 2.2 -1.7

### Fiscal outlook and financing
- Primary fiscal deficit:
  - Central government primary fiscal deficit outturn in FY2018/19: 4.0 percent of GDP (decreased from 6.1 percent of GDP in previous year).
  - FY2019/20 primary fiscal deficit projected at 3.9 percent of GDP (taking into account spending capacity constraints).
  - Medium-term projection: primary deficit projected to decrease to 3.2 percent of GDP.
- Domestic borrowing:
  - Government expected to gradually increase domestic borrowing to meet its fiscal deficit.
  - Domestic borrowing expected to reach 4 percent of GDP annually.
  - Domestic debt stock projected to increase from 13 percent to 35½ percent of GDP over the long-term.
  - External debt stock projected to decrease to 11 percent of GDP over the projection period.
- Realism of baseline:
  - Baseline fiscal adjustment: 0.5 percentage point in 3 years considered feasible based on cross-country experience.
  - Using alternative fiscal multipliers, growth would be higher than in the baseline scenario.
  - Contribution of public capital to GDP growth in the baseline projection is in line with historical experiences.

### Country classification and stress testing
- Debt carrying capacity:
  - Composite indicator (CI) calculated at 3.28 based on October 2019 WEO and 2018 CPIA index.
  - CI lies in the range of "strong" rating (same as last year).
- Application thresholds:
  - PV of debt in % of Exports: 240
  - PV of debt in % of GDP: 55
  - Debt service in % of Exports: 21
  - Debt service in % of Revenue: 23
  - Total public debt benchmark (PV of total public debt in % of GDP): 70
- Stress tests:
  - All stress tests kept at default settings (historical average minus one standard deviation, or baseline minus one standard deviation, whichever is lower) with an additional tailored natural disaster shock.
  - Natural disaster shock: one-off shock of 10 percentage points of GDP to the debt-to-GDP ratio in the second year of the projection period (FY2020/21); real GDP growth and exports lowered by 1.5 and 3.5 percent, respectively, in the year of the shock.

### External and public sustainability results
- External DSA:
  - Nepal is at low risk of debt distress.
  - Under the baseline, PV of external debt and debt service ratios projected not to breach thresholds and to remain stable over the projection period, even assuming private external debt grows to 1 percent of GDP.
  - In stress tests, debt and debt service ratios remain below thresholds throughout the projection period.
- Vulnerabilities:
  - Export shock is the most extreme identified; under the export shock, PV of public external debt-to-export ratio would increase to 213 percent at mid-2022 (below threshold value 240 percent) and then stabilize.
- Public (external + domestic) debt:
  - Projected to increase from 30 percent of GDP at July 2018/19 to around 46 percent of GDP in FY2039/40 under the baseline scenario.
  - PV of the debt-to-GDP ratio projected to remain stable at 38 percent of GDP over the projection period (well below 70 percent benchmark).
  - Debt service-to-revenue ratio projected to rise over the projection period to 36 percent, but to remain below 40 percent in 2029/30.
- Shock sensitivity:
  - Public debt most vulnerable to a growth shock: a growth shock (one standard deviation in 2020/21 from the baseline) would raise PV of debt-to-GDP ratio to 55 percent in 2029/30.
  - Debt service-to-revenue ratio under the growth shock calculated at around 53 percent in 2029/30.

### Views of the authorities and institutional developments
- Authorities broadly agreed with the DSA assessment and stressed that public debt risk has been reduced over the past decade due to effective management of public finances.
- Fiscal federalism context:
  - Steps taken to enhance public debt management.
  - New Public Debt Management bill submitted to Parliament.
  - Public Debt Management Office (PDMO) established in FY 2018/19 to manage public debt in an integrated manner.
  - PDMO will prepare guidelines to support subnational governments in appropriate management of borrowings and debts.
- Authorities concurred that the share of domestic financing out of total government financing would increase over time and noted that domestic financing size could be further increased with continued economic growth.

*Source: Nepalese authorities; and IMF staff estimates.*

### 19.      Nepal remains at low risk of external and overall debt distress.  Both in the baseline scenario

### 19.      Nepal remains at low risk of external and overall debt distress.  Both in the baseline scenario

### Debt risk assessment and outlook
- Nepal remains at low risk of external and overall debt distress.  
- Both in the baseline scenario and in the stress tests, none of debt burden indicators breach the indicative threshold values.  
- Baseline projections and the standard stress tests show increasing risks for the projection period.  
- Nepal’s public debt is projected to gradually increase over the medium-term owing to continuing fiscal and current account deficits.  
- Stress tests indicate that Nepal’s debt sustainability remains vulnerable to shocks to exports and economic growth.

### Policy recommendations and priorities
- Continue efforts to improve domestic productivity and competitiveness through stepping up quality investment in infrastructure, as well as streamlining regulations and bureaucratic processes.  
- Pursue rigorous analysis of the risks related to contingent liabilities.  
- Close the data gap by compiling PPP projects and private sector external debt to help future debt sustainability analysis.  
- Make significant progress in implementing a medium-term debt strategy and developing the government bond market to facilitate greater domestic financing.  
- Improve subnational governments’ public financial management and reporting, and implement a prudent framework for subnational borrowing.

### Selected key statistics and projections (as presented)
- External debt (nominal) 1/ 17.118.518.818.919.019.018.816.811.818.718.3  
- of which: public and publicly guaranteed (PPG)17.018.318.618.718.718.718.416.210.818.717.9  
- Change in external debt-0.21.40.30.10.10.0-0.2-0.5-0.6  
- Identified net debt-creating flows 6.43.83.53.43.33.12.91.91.6-2.62.9  
- Non-interest current account deficit7.65.04.84.74.64.44.23.42.8-0.64.2  
- Deficit in balance of goods and services37.534.633.432.431.530.629.625.214.229.829.7  
- Exports 8.78.48.48.58.68.68.78.89.1  
- Imports 46.242.941.840.940.139.238.334.023.3  
- Net current transfers (negative = inflow)-28.7-28.2-27.3-26.4-25.6-24.9-24.0-20.5-15.3-29.2-24.1  
- Endogenous debt dynamics 2/ -0.8-0.8-0.8-0.8-0.8-0.8-0.8-0.7-0.5  
- Residual 3/ -6.6-2.4-3.2-3.3-3.2-3.1-3.1-2.4-2.31.4-2.9  
- PV of PPG external debt-to-GDP ratio12.212.212.212.112.011.911.610.06.7  
- PV of PPG external debt-to-exports ratio140.6145.6144.5142.5140.2137.4133.8113.673.4  
- PPG debt service-to-exports ratio8.07.97.57.47.57.87.46.54.4  
- PPG debt service-to-revenue ratio2.82.72.62.62.72.82.62.41.7  
- Gross external financing need (Million of U.S. dollars)2427.81829.91908.92058.82228.82354.22449.23038.86619.7

### Public sector debt highlights
- Public sector debt 1/30.133.735.737.439.040.341.143.646.330.640.1  
- of which: external debt17.018.318.618.718.718.718.416.210.818.717.9  
- of which: local-currency denominated13.115.417.118.820.321.622.627.435.5  
- Change in public sector debt-0.23.62.01.71.61.30.80.40.0  
- Identified debt-creating flows0.81.81.41.10.90.60.2-0.1-0.5-2.00.5  
- Primary deficit4.03.93.73.43.33.02.82.62.50.53.0  
- Revenue and grants26.025.826.025.825.525.625.525.225.321.325.5  
- Primary (noninterest) expenditure30.029.829.729.228.928.628.327.827.721.928.5  
- Automatic debt dynamics-3.2-2.1-2.3-2.4-2.4-2.4-2.6-2.7-3.0  
- Residual 7/-0.91.80.60.60.60.70.60.50.50.90.7  
- PV of public debt-to-GDP ratio 2/ 24.927.829.531.032.433.634.437.642.3  
- PV of public debt-to-revenue and grants ratio95.7107.4113.4120.2126.9131.3134.8149.1167.4  
- Debt service-to-revenue and grants ratio 3/24.426.321.622.425.027.930.435.845.4  
- Gross financing need 4/10.310.79.39.29.710.110.611.613.9

### Key macroeconomic assumptions (selected)
- Real GDP growth (in percent)7.16.05.75.55.45.35.35.35.34.95.4  
- GDP deflator in US dollar terms (change in percent)-1.34.83.83.63.43.23.83.53.54.33.6  
- Effective interest rate (percent) 4/ 0.80.80.80.80.80.90.91.01.30.90.9  
- Growth of exports of G&S (US dollar terms, in percent)2.57.710.29.910.09.59.99.39.45.89.4  
- Growth of imports of G&S (US dollar terms, in percent)5.63.36.86.86.86.56.66.46.612.96.3  
- Government revenues (excluding grants, in percent of GDP)24.824.624.524.424.124.224.124.024.1  
- Aid flows (in Million of US dollars) 5/ 368.3 933.81012.91050.01131.61185.11237.31537.42898.6  
- Nominal GDP (Million of US dollars)  30690.334080.937381.940846.744498.548374.352868.181362.5192701.7

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

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_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1nplea2020001.pdf_