## 1nplea2023002

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---

### Climate change and food insecurity — context and headline quantitative results
- Average temperature in Nepal in the last decade is over 0.6 degrees higher than the baseline of 1950-1980.
- UNEP estimates that floods alone could cost Nepal the equivalent of 2.7 percent of GDP per annum.
- In a severe climate change scenario, the World Bank estimate that GDP would be 7 percent lower by 2050.
- Food insecurity has grown every year between 2015 and 2020 and currently affects more than one third of the population.
- World Food Programme: 18 percent of the population reported not having consumed an adequate diet in October 2022.
- In October 2022, 27.8 percent of households were impacted by a decrease in remittances received.
- Headline quantitative results from the paper:
  - Low yields and remoteness explain most (63 percent) of the difference in the prevalence of food insecurity across districts in Nepal.
  - Both climate shocks and persistent climate-change increase food insecurity and disproportionately harm the most vulnerable (10 percent lower yields → 4 percent increase in prevalence of undernourishment).
  - Lower wages in oil producing countries (modeled as 25 percent decrease in wages) → 10 percent decrease in remittances → 7 percent increase in prevalence of undernourishment.

### Model structure, calibration, and determinants of undernourishment
- Model key elements:
  - Role of food: food is a necessity good; model disaggregates production and consumption into differentiated food products with varying nutritional contents.
  - Heterogeneity: spatial variation in crop suitability and local shocks; household-level heterogeneity via farm endowments; undernourished defined by inability to consume sufficient calories at market prices; calorie deficit defined as calories needed to make the household no longer undernourished.
  - Spatial frictions: trade and migration routes connect regions; shocks propagate via general equilibrium price channels along trade and migration routes.
- Calibration:
  - Calibrated for 50 Nepalese districts plus the Kathmandu valley area using HRVS 2016-18, census data, international trade data, and externally calibrated parameters.
- Empirical correlations on determinants of undernourishment:
  - Districts with 1 percent higher agricultural yields have on average 0.7 percent fewer undernourished households.
  - More remote regions are significantly more undernourished.
  - Regions that import more and have more migrants initially show higher prevalence of undernourishment, but when controlling for agricultural yields, importing food and migrating lowers undernourishment (interpretation: low yields drive the coping strategies of importing and migration).

### Impact of localized climate shocks (25 percent district yield shock)
- Shock specification: 25 percent lower agricultural yield in one district for one period (simulates a significant localized flood).
- Immediate and short-run median household impulse responses:
  - Food prices jump by an average of 4 percent in affected districts.
  - Food and non-food consumption falls by an average of over 6 percent.
  - For some poorer households, non-food consumption drops by up to 15 percent.
  - Assets fall by over 3.5 percent.
  - Import shares increase 20 percent.
  - Migration and remittances increase 10 percent.
- Welfare and food insecurity impacts:
  - Contemporaneous 5 percentage point increase in undernourished households in impacted districts.
  - 23 percent increase in calorie deficit (severity of undernourishment).
  - Average 6.5 percent fall in welfare.
  - Although yield shock lasts one period, impacts on consumption, assets, undernourishment and welfare last up to five harvests as households gradually recover.
- Mitigating factors:
  - Having 1 percent higher agricultural yields lowers the impact of a 25 percent shock by between 4 and 12 percent.
  - Being in a less remote district reduces the shock’s impact because households can more easily import food or migrate.

### Impact of persistent national climate change (10 percent permanent productivity reduction)
- Experiment: permanent 10 percent nationwide reduction in agricultural productivity.
- Results:
  - Large spike in migration away from agricultural areas and corresponding increase in remittances.
  - Food insecurity rises by 4 percent.
  - Net effect on welfare is particularly large driven by migration as households move away from their homes in rural areas.

### Global wage shock in fossil-fuel migrant destinations (25 percent wage decline)
- Scenario: 25 percent lower wages in oil producing migrant destinations (modeled as global transition lowering demand for fossil fuels).
- Results:
  - Migration and remittances drop.
  - Remittances fall by 10 percent (linked to the 25 percent wage shock).
  - Prevalence of undernourishment increases by 7 percent.
  - Lower remittances remove a key household safety net, increasing food insecurity and lowering welfare substantially.

### Policy options and quantified impacts — migration, trade costs, and cash transfers
- Lowering migration costs by 25 percent (better roads, more information, migrant support):
  - Steady state: households are 6 percent less food insecure on average.
  - Steady state: households have almost 10 percent higher welfare.
  - All income deciles benefit; the bottom quartile benefits the most.
  - Following a shock, welfare losses are approximately 1 percentage point lower because households can use migration to support agricultural income.
  - Lower migration costs enable households to rely on migration as a coping strategy and avoid drawing down assets, shortening shock duration.
- Lowering trade costs by 25 percent (better road infrastructure):
  - Steady state: food insecurity falls 18 percent compared to baseline.
  - Higher welfare for all income quartiles.
  - Following a 25 percent yield shock, welfare is approximately 1 percentage point higher versus baseline.
  - Mechanism: improved ability to import food reduces local price spikes and the need to cut food consumption.
- Cash transfers (income tax of 1 percent on all households; revenues equally distributed to bottom quartile):
  - Steady-state: welfare falls in the top three income quartiles and increases in the bottom quartile.
  - Net effect on both welfare and food insecurity is strongly positive.
  - Following a shock, welfare losses for the bottom quartile are lower and the policy helps households maintain assets and shortens shock duration.
  - Implementation caveat: illustrative policy; revenue could be generated from multiple sources; cash transfers have empirical benefits but can be difficult to implement and subject to leakages.
- Increasing agricultural productivity — cross-country lessons and options for Nepal:
  - International examples: agricultural extension, community water management, climate resilient agriculture (National Adaptation Plan, 2021); Zambia and Bangladesh: training and sustainability incentives; China: digitalization tools for farmers and weather forecasting; Morocco: supported irrigation systems; Maharashtra (India): drainage lines and incentivizing climate resilient seed varieties.
  - Domestic measures: incentivize private sector agri-logistics and cold chains; improve payment systems and microinsurance for crop and livestock; improve soil nutrients to support carbon sinks and stress tolerant crops.

### Fertilizer availability, prices, and policy response
- Key facts:
  - Nepal imports 100 percent of mineral fertilizer.
  - The price of urea fertilizer increased 64 percent in 2022 (IMF, 2022).
  - The government purchased close to 100,000 tons of fertilizers from India to cushion shocks.
  - A 2014 USAID study reports that 70 percent of the fertilizers in Nepal are procured by local farmers through improper channels (USAID, 2014).
  - The fertilizer subsidy mostly supplies urea fertilizers and has been reported to encourage unbalanced fertilizer use (World Bank Group, 2022).
  - Import, distribution, and sale of fertilizers in Nepal is highly regulated and restricted to two companies; shortages have led farmers to black market purchases at two or three times actual cost.
- Policy recommendation:
  - Consider gradual opening of the sector to private enterprise by encouraging domestic production, import, distribution, and sales to reduce shortages and delays and help generate a domestic fertilizer industry.

### Public enterprises (PEs) overview, fiscal risks, and pandemic impacts
- Structure and scale:
  - There are currently 42 PEs: 10 in industrial sector, 4 in trading sector, 9 in services sector, 5 in social sector, 5 in public utility sector and 9 in financial sector.
  - Total assets reached 51 percent of GDP and liabilities 33 percent in FY2020/21.
  - Top ten PEs (by assets) account for 94 percent of assets and 91 percent of liabilities of all PEs.
- Governance and oversight:
  - PEs formed under different Acts; 33 PEs under Companies Act, others under special acts, Cooperative Act, or the Corporation Act.
  - No centralized ownership policies or central guidelines on financial oversight of PEs.
  - MOF exercises certain financial oversight and control; line ministries assume policy and ownership roles.
- Pandemic and commodity shock impacts:
  - Total profits of PE sector were increasing before FY2018/19 but plunged during the pandemic.
  - Profits reduced by 0.5 percent of GDP in FY2020/21, as almost half of PEs ran in loss that year.
  - NOC was the biggest loss maker at 0.09 percent of GDP in FY2020/21.
  - NOC incurred 1 percent of GDP losses in FY2021/22 because surging fuel purchasing costs were not fully passed through to domestic fuel sales prices.
  - Non-financial PEs’ liabilities increased by 31 percent from FY2018/19 to FY2020/21.
  - Financial PEs’ liabilities increased by 44 percent from FY2018/19 to FY2020/21.
  - Unfunded liabilities and contingent liabilities are large: 26 percent of GDP in FY2020/21.
  - About 80 percent of unfunded liabilities arise from the utility sector (mainly NEA).
  - Contingent liabilities are mainly from the Deposit and Credit Guarantee Fund (86 percent of total contingent liabilities).

### Case study — Nepal Oil Corporation (NOC)
- Market and financial magnitudes:
  - NOC is the only company authorized to import petroleum products into Nepal; imports exclusively from Indian Oil Corporation under long-term contracts; no domestic competition.
  - NOC incurred losses of NRP 0.4 billion in FY2020/21.
  - NOC incurred losses of NRP 47.5 billion (1 percent of GDP) in FY2021/22.
  - NOC recorded profits of NRP 12.9 billion (0.3 percent of GDP) in FY2019/20.
  - NOC was able to absorb NRP 17 billion (0.4 percent of GDP) loss with previously accumulated profits, drawing down cash balances and financial investments (including oil price stabilization fund).
  - Outstanding payment to Indian Oil Corporation was around NRP 31 billion/0.7 percent of GDP by mid-August 2022 (later converted into loans).
  - Loans from one state-owned bank amounted to NRP 3 billion/0.1 percent of GDP.
  - Government provided NRP 7 billion (0.14 percent of GDP) to support NOC to repay its loan and clear some outstanding payments.
- Risk and pricing:
  - Applying the SOE-HCT tool, NOC’s overall risk rating increased from category 2 in FY2018/19 to 4 in FY2021/22 (scale: 1 very low risk; 2 low risk; 3 moderate risk; 4 high risk; 5 very high risk).
  - From July 15, 2020, to July 5, 2022, domestic petrol and diesel selling prices increased 77.5 percent and 95.5 percent respectively, while international market prices for them increased much more (New York Harbor prices increased 176.2 percent and 204.8 percent respectively in the same period).
  - Automatic fuel pricing mechanism allows NOC to increase domestic fuel prices up to 2 percent every two weeks; increases beyond that require board approval.
  - Estimated forgone revenue (QFA cost) in FY2021/22: about 1.2 percent of GDP.
  - Even if NOC returns to pre-pandemic level of profits, it would take more than three years to fully recover accumulated loss and repay loans if QFAs continue.

### Case study — Nepal Airlines Corporation (NAC)
- Market shares and financial trajectory:
  - 20 domestic airlines and 29 international airlines operate in Nepal.
  - NAC domestic flight market share in 2021: 1 percent.
  - NAC international flight market share in 2021: 19.7 percent.
  - Losses in FY2018/19: NPR 2.1 billion (0.05 percent of GDP); accumulated loss by end of FY2018/19: NPR 5.6 billion (0.15 percent of GDP).
  - Losses widened to NPR 3.9 billion in FY2019/20 (0.1 percent of GDP) and NPR 4.9 billion in FY2020/21 (0.11 percent of GDP); loss reduced to NPR 2.8 billion in FY2021/22 (0.06 percent of GDP).
  - NAC’s liabilities exceeded total assets since FY2020/21, resulting in negative equity worsening in FY2021/22.
- Government credit exposure by end-FY2021/22:
  - Outstanding loans: NPR 3.6 billion (0.1 percent of GDP).
  - Debt guarantees: NPR 34 billion (0.7 percent of GDP).

### Case study — Nepal Electricity Authority (NEA)
- Pandemic measures and fiscal cost:
  - Government introduced free electricity to households consuming up to 10 units per month with 5-ampere meters in FY2020/21; extended to up to 20 units per month in late 2021.
  - FY2021/22 forgone revenue from free electricity: Units distributed free: 85.99 million units; Estimated forgone revenue: about NPR 558.9 million (0.01 percent of GDP).
- Financial performance and risks:
  - FY2021/22 total profits: NPR 16.1 billion (0.3 percent of GDP).
  - Thermal power plants capacity: 8.1 percent of total electricity generation capacity.
  - Debt to EBITDA declined from 24.3 in FY2018/19 to 17.1 by end-FY2021/22; threshold for high-risk category is five (SOE-HCT).
  - NEA classified in highest risk category for debt to EBITDA and debt coverage indicators.
  - Unfunded liabilities (mainly pension liabilities) increased to 0.7 percent of GDP by end-FY2020/21.
  - Liquidity management concerns: debtor turnover days and creditor turnover days classified in highest risk category.
- PPAs and capacity risk:
  - Signed PPAs by end-FY2021/22: 357 PPAs; combined installed capacity: 6,366 MW.
  - Additional PPA applications: 269 applications with total capacity 11,740 MW → potential total capacity 18,106 MW.
  - Electricity demand forecast ranges (Water and Energy Commission Secretariat’s Electricity Demand Forecast Report 2015-2040):
    - 2025: 5,787 MW - 10,803 MW.
    - 2030: 8,937 MW - 18,371 MW.
    - 2040: 19,151 MW - 51,330 MW.
  - If electricity demand falls short of expectations, NEA may incur losses from take-or-pay PPA commitments.

### Fiscal impact channels and magnitudes through PEs
- Early pandemic (FY2019/20):
  - Income tax contributed by PEs increased close to 0.1 percentage point of GDP.
  - Dividends increased a little more than 0.1 percentage point of GDP.
  - Fertilizer subsidies increased close to 0.1 percentage point of GDP.
  - Net above-the-line impact of pandemic through PEs (compared to FY2018/19): positive 0.1 percent of GDP.
  - Share investment and loan investment to PEs fell by 1 percentage point of GDP in FY2019/20.
- Subsequent fiscal deterioration (FY2020/21 and FY2021/22):
  - PEs’ contribution to fiscal revenue (income tax and dividends) declined by 0.16 percentage point of GDP in FY2020/21 and 0.23 percentage point of GDP in FY2021/22 (compared with FY2018/19).
  - Fiscal subsidies to PEs increased by 0.1 percentage point of GDP in each of FY2020/21 and FY2021/22.
  - Overall fiscal costs added to deficits: 0.26 percentage point of GDP in FY2020/21 and 0.32 percentage point of GDP in FY2021/22.
  - Government purchased 0.14 percent of GDP in NOC loans in FY2021/22.
  - Government loans to the PE sector by end-FY2020/21: NPR 252.6 billion (5.9 percent of GDP) — 0.9 percentage point of GDP higher than FY2018/19.
  - Around 80 percent of government loans go to NEA.

### Deposit and Credit Guarantee Fund (DCGF) — guarantees and fiscal vulnerability
- Activity and size:
  - Average credit guarantee amount increased by 148.1 percent between mid-July 2021 to mid-January 2023 relative to mid-July 2018 to mid-July 2021 (pre-COVID period).
  - Average increase in claims paid to banks: 48 percent.
  - Credit guarantee fund size: NPR 3.55 billion (less than 0.1 percent of FY2022/23 GDP).
  - Total guaranteed credit amount: NPR 265.28 billion (4.9 percent of FY2022/23 GDP).
  - Fund corresponds to 1.34 percent of the total guaranteed credit amount.
  - Concessional loans within guaranteed amount: 62 billion (1.1 percent of FY2022/23 GDP).
- Vulnerabilities:
  - No target size for the credit guarantee fund.
  - Given total guaranteed amount of concessional loans is 1.1 percent of GDP as of mid-January 2023, repayment of claims corresponding to more than 5.7 percent of the guaranteed amount would exhaust the current credit guarantee fund.
  - Rising NPL levels suggest bank claims on other guaranteed loans (especially microfinance and SME sectors) may increase.
  - Recovery rates after reimbursement are on average below 0.01 percent, indicating significant moral hazard.
- Selected program parameters (reported):
  - Micro Finance and Deprived Sector Credit Guarantee: Guarantee Limit up to Rs. 1.5 million; Guarantee Fee 1% p.a. (75% subsidy from government); Compensation 75 percent.
  - Agricultural Credit Guarantee: Guarantee Limit up to Rs 20. Million; Guarantee Fee 0.6% p.a. (50% subsidy); Compensation 70 - 80 percent.
  - Educational Credit Guarantee: Rs 1 million; Educated Unemployment Business Credit Guarantee: Rs 0.5 million; Guarantee Fee 1% p.a. (80% subsidy); Compensation 80 percent.
  - Small and Medium Enterprises Credit Guarantee: Up to Rs 20 million; Guarantee Fee 0.6% p.a. (50% subsidy); Compensation 70 – 80 percent.
  - Livestock Guarantee: For large livestock – Rs 0.15 million; For small livestock – Rs 30,000; Guarantee Fee 6% p.a. (75% subsidy); Compensation 90 (death) / 50 (unproductive).
  - Export Credit Guarantee: Up to Rs. 1 million; Guarantee Fee 1% p.a. (50% subsidy); Compensation 70-80 percent.

*Source: 1nplea2023002 - 1.    Climate Change and Food Insecurity in Nepal (excerpt).*

### 1.    Climate Change and Food Insecurity in Nepal ________________________________________ 5

### 1.    Climate Change and Food Insecurity in Nepal

### Context and key background
- Average temperature in Nepal in the last decade is over 0.6 degrees higher than the baseline of 1950-1980.
- UNEP estimates that floods alone could cost Nepal the equivalent of 2.7 percent of GDP per annum.
- In a severe climate change scenario, the World Bank estimate that GDP would be 7 percent lower by 2050.
- Food insecurity has grown every year between 2015 and 2020 and currently affects more than one third of the population.
- World Food Programme: 18 percent of the population reported not having consumed an adequate diet in October 2022.
- In October 2022, 27.8 percent of households were impacted by a decrease in remittances received.
- The paper’s three headline quantitative results:
  - Low yields and remoteness explain most (63 percent) of the difference in the prevalence of food insecurity across districts in Nepal.
  - Both climate shocks and persistent climate-change increase food insecurity and disproportionately harm the most vulnerable (10 percent lower yields → 4 percent increase in prevalence of undernourishment).
  - Lower wages in oil producing countries (modeled as 25 percent decrease in wages) → 10 percent decrease in remittances → 7 percent increase in prevalence of undernourishment.

### Model structure and calibration
- Macro-spatial model calibrated to Nepal with three key elements:
  - Role of food: food is a necessity good; model disaggregates production and consumption into differentiated food products with varying nutritional contents.
  - Heterogeneity: spatial variation in crop suitability and local shocks across regions; household-level heterogeneity via farm endowments; undernourished defined by inability to consume sufficient calories at market prices; calorie deficit defined as calories needed to make the household no longer undernourished.
  - Spatial frictions: trade and migration routes connect regions; shocks propagate via general equilibrium price channels along trade and migration routes.
- Calibration details:
  - Calibrated for 50 Nepalese districts plus the Kathmandu valley area using HRVS 2016-18, census data, international trade data, and externally calibrated parameters.

### Determinants of undernourishment (equilibrium)
- Empirical model correlations:
  - Districts with 1 percent higher agricultural yields have on average 0.7 percent fewer undernourished households.
  - More remote regions are significantly more undernourished.
  - Regions that import more and have more migrants initially show higher prevalence of undernourishment, but when controlling for agricultural yields, importing food and migrating lowers undernourishment (interpretation: low yields drive the coping strategies of importing and migration).

### Impact of localized climate shocks (experiment)
- Shock specification: 25 percent lower agricultural yield in one district for one period (simulates a significant localized flood).
- Immediate and short-run responses (median household average impulse responses):
  - Food prices jump by an average of 4 percent in affected districts.
  - Food and non-food consumption falls by an average of over 6 percent.
  - For some poorer households, non-food consumption drops by up to 15 percent.
  - Assets fall by over 3.5 percent.
  - Import shares increase 20 percent.
  - Migration and remittances increase 10 percent.
- Welfare and food insecurity impacts:
  - Contemporaneous 5 percentage point increase in undernourished households in impacted districts.
  - 23 percent increase in calorie deficit (severity of undernourishment).
  - Average 6.5 percent fall in welfare.
  - Although yield shock lasts one period, impacts on consumption, assets, undernourishment and welfare last up to five harvests as households gradually recover.
- Mitigating factors:
  - Having 1 percent higher agricultural yields lowers the impact of a 25 percent shock by between 4 and 12 percent.
  - Being in a less remote district reduces the shock’s impact because households can more easily import food or migrate.

### Impact of persistent climate change (national)
- Experiment: permanent 10 percent nationwide reduction in agricultural productivity.
- Results:
  - Large spike in migration away from agricultural areas and corresponding increase in remittances.
  - Food insecurity rises by 4 percent.
  - Net effect on welfare is particularly large driven by migration as households move away from their homes in rural areas.

### Impact of a global shift in wages in fossil-fuel-producing migrant destinations
- Scenario: 25 percent lower wages in oil producing migrant destinations (modeled as global transition lowering demand for fossil fuels).
- Results:
  - Migration and remittances drop.
  - Remittances fall by 10 percent (linked to the 25 percent wage shock).
  - Prevalence of undernourishment increases by 7 percent.
  - Lower remittances remove a key household safety net, increasing food insecurity and lowering welfare substantially.

### Policy options and quantified impacts
- Lowering migration costs by 25 percent (via better road infrastructure, more information to migrants, better migrant support):
  - Steady state: households are 6 percent less food insecure on average.
  - Steady state: households have almost 10 percent higher welfare.
  - All income deciles benefit; the bottom quartile benefits the most.
  - Following a shock, welfare losses are approximately 1 percentage point lower because households can use migration to support agricultural income.
  - Lower migration costs enable households to rely on migration as a coping strategy and avoid drawing down assets, shortening shock duration.
- Lowering trade costs by 25 percent (via better road infrastructure):
  - Steady state: food insecurity falls 18 percent compared to baseline.
  - Higher welfare for all income quartiles.
  - Following a 25 percent yield shock, welfare is approximately 1 percentage point higher versus baseline.
  - Mechanism: improved ability to import food reduces local price spikes and the need to cut food consumption.
- Cash transfers:
  - Distributional impacts presented in the source (figure referenced); the paper quantifies cash transfer effects on food insecurity and welfare (figures and distributional results provided in the chapter).

*Source: 1nplea2023002 - 1.    Climate Change and Food Insecurity in Nepal ________________________________________ 5*

### 14.      Figure 8 shows how government social support through cash transfers can reduce

### 1nplea2023002 - 14.      Figure 8 shows how government social support through cash transfers can reduce

### Cash transfers, food insecurity, and resilience
- Policy experiment design:
  - All households (rural and urban) pay an income tax of 1 percent.
  - All tax revenues are distributed equally among households in the bottom quartile of real income.
  - Could be implemented as an expansion of the government’s Child Cash Grant scheme.
- Steady-state effects:
  - Welfare falls in the top three income quartiles.
  - Welfare increases in the bottom quartile.
  - Net effect on both welfare and food insecurity is strongly positive.
  - Rationale: the bottom quartile are much closer to the food insecurity threshold, so transfers substantially increase their wellbeing.
- Shock resilience:
  - Following a shock, welfare losses for the bottom quartile are lower because they can rely on the cash grant to support food consumption.
  - The policy helps households maintain their assets and shortens the duration of the shock’s impact.
- Implementation caveat:
  - The particular policy is illustrative; the revenue could be generated from any number of sources.
  - There is a large empirical literature pointing to the benefits of cash transfers, but they can sometimes be difficult to implement and subject to leakages.

### Increasing agricultural productivity — cross-country lessons and options for Nepal
- Policy options and international examples:
  - Agricultural extension, improved community water management techniques, and climate resilient agriculture in line with the National Adaptation Plan (2021).
  - Zambia and Bangladesh: training and sustainability incentives in livestock and agriculture to promote efficient storage of water in soil and prevent biodiversity loss.
  - China: digitalization tools to inform farmers of best practices and accurate weather forecasting.
  - Morocco: supported irrigation systems to provide optimal water based on crop needs.
  - Maharashtra (India): building drainage lines to maximize surface water utility and better use of groundwater; incentivizing adoption of climate resilient seed varieties (drought and heat resistant).
- Domestic measures suggested:
  - Incentivize private sector capacity building for agri-logistics and cold chains to prevent post-harvest losses.
  - Improve payment systems and microinsurance coverage for crop and livestock to boost labor productivity and resilience to climate shocks.
  - Improve soil nutrients to support growth of agricultural plants that are carbon sinks and stress tolerant (NAP, 2021).

### Fertilizer availability, prices, and policy response
- Key facts and statistics:
  - Nepal imports 100 percent of mineral fertilizer.
  - The price of urea fertilizer increased 64 percent in 2022 (IMF, 2022).
  - The government purchased close to 100,000 tons of fertilizers from India to cushion shocks.
  - A 2014 USAID study reports that 70 percent of the fertilizers in Nepal are procured by local farmers through improper channels (USAID, 2014).
  - The fertilizer subsidy mostly supplies urea fertilizers and has been reported to encourage unbalanced fertilizer use (World Bank Group, 2022).
  - Import, distribution, and sale of fertilizers in Nepal is highly regulated and restricted to two companies; shortages have led farmers to black market purchases at two or three times actual cost.
- Policy recommendations:
  - Consider gradual opening of the sector to private enterprise by encouraging domestic production, import, distribution, and sales.
  - Aim to reduce shortages and delays and help generate a domestic fertilizer industry.

### Public enterprises (PEs) overview and fiscal risks
- Structure and scale:
  - There are currently 42 PEs: 10 in industrial sector, 4 in trading sector, 9 in services sector, 5 in social sector, 5 in public utility sector and 9 in financial sector.
  - Total assets reached 51 percent of GDP and liabilities 33 percent in FY2020/21.
  - Top ten PEs (by assets) account for 94 percent of assets and 91 percent of liabilities of all PEs.
  - PEs are vehicles for sectoral development investment, concentrated in electricity and civil aviation.
- Governance and oversight:
  - PEs formed under different Acts; 33 PEs under Companies Act, others under special acts, Cooperative Act, or the Corporation Act.
  - No centralized ownership policies or central guidelines on financial oversight of PEs.
  - MOF exercises certain financial oversight and control; line ministries assume policy and ownership roles.
  - PEs submit annual financial statements to MOF for consolidated reporting; external borrowing requires government consent, while domestic borrowing may not.

### Impacts of COVID-19 and commodity shocks on PEs’ financial performance
- Aggregate performance and liabilities:
  - Total profits of PE sector were increasing before FY2018/19 but plunged during the pandemic.
  - Profits reduced by 0.5 percent of GDP in FY2020/21, as almost half of PEs ran in loss that year.
  - NAC was the biggest loss maker at 0.09 percent of GDP in FY2020/21.
  - NOC was profitable at 0.33 percent of GDP in FY2019/20 but turned into a loss subsequently.
  - Non-financial PEs’ liabilities increased by 31 percent from FY2018/19 to FY2020/21.
  - Financial PEs’ liabilities increased by 44 percent from FY2018/19 to FY2020/21.
  - Unfunded liabilities and contingent liabilities are large: 26 percent of GDP in FY2020/21.
  - About 80 percent of unfunded liabilities arise from the utility sector (mainly NEA).
  - Contingent liabilities are mainly from the Deposit and Credit Guarantee Fund (86 percent of total contingent liabilities).
- Role of global commodity price shocks:
  - Recent global commodity price shocks further affected PEs’ financial performance; NOC incurred 1 percent of GDP losses in FY2021/22 because surging fuel purchasing costs were not fully passed through to domestic fuel sales prices.

### Case study: Nepal Oil Corporation (NOC)
- Market position:
  - NOC is the only company authorized to import petroleum products into Nepal; imports exclusively from Indian Oil Corporation under long-term contracts; no domestic competition.
- Financial trajectory and magnitudes:
  - NOC incurred losses of NRP 0.4 billion in FY2020/21.
  - NOC incurred losses of NRP 47.5 billion (1 percent of GDP) in FY2021/22.
  - NOC recorded profits of NRP 12.9 billion (0.3 percent of GDP) in FY2019/20.
  - NOC was able to absorb NRP 17 billion (0.4 percent of GDP) loss with previously accumulated profits, drawing down cash balances and financial investments (including oil price stabilization fund).
  - Outstanding payment to Indian Oil Corporation was around NRP 31 billion/0.7 percent of GDP by mid-August 2022 (later converted into loans).
  - Loans from one state-owned bank amounted to NRP 3 billion/0.1 percent of GDP.
  - Government provided NRP 7 billion (0.14 percent of GDP) to support NOC to repay its loan and clear some outstanding payments.
- Risk assessment:
  - Applying the SOE-HCT tool, NOC’s overall risk rating increased from category 2 in FY2018/19 to 4 in FY2021/22 (scale: 1 very low risk; 2 low risk; 3 moderate risk; 4 high risk; 5 very high risk), indicating a jump from low to high probability of financial distress.
- Price pass-through dynamics:
  - From July 15, 2020, to July 5, 2022 (end of FY2019/20 to FY2021/22), domestic petrol and diesel selling prices increased 77.5 percent and 95.5 percent respectively, while international market prices for them increased much more.
  - For example, New York Harbor prices for petrol and diesel increased 176.2 percent and  (text ends).

*Source: 1nplea2023002 - Nepal (INTERNATIONAL MONETARY FUND)*

### 204.8 percent respectively in the same period.

### 1nplea2023002 - 204.8 percent respectively in the same period.

### Nepal Oil Corporation (NOC): losses, pricing mechanism, and quasi-fiscal activities
- NOC faced mounting losses as import fuel price surges were not fully passed through to domestic market.
- Automatic fuel pricing mechanism allows NOC to increase domestic fuel prices up to 2 percent every two weeks; increases beyond that require board approval.
- Government concerns about social and economic impact of high fuel prices limited pass-through.
- Estimated forgone revenue (QFA cost) in FY2021/22: about 1.2 percent of GDP.
- Recent fall in global fuel prices helped NOC recover part of its loss, but:
  - Even if NOC returns to pre-pandemic level of profits, it would take more than three years to fully recover accumulated loss and repay loans.
  - If profits are not sustained and QFAs continue, NOC’s vulnerable financial situation will be prolonged.

### Nepal Airlines Corporation (NAC): market position, financial deterioration, and government exposure
- Market structure and shares:
  - 20 domestic airlines and 29 international airlines operate in Nepal.
  - NAC domestic flight market share in 2021: 1 percent.
  - NAC international flight market share in 2021: 19.7 percent.
- Pre-pandemic financial position (FY2018/19):
  - Losses in FY2018/19: NPR 2.1 billion (0.05 percent of GDP).
  - Accumulated loss by end of FY2018/19: NPR 5.6 billion (0.15 percent of GDP).
  - Risk rating by SOE-HCT was already high in FY2018/19.
- Pandemic impact and subsequent years:
  - Losses widened to NPR 3.9 billion in FY2019/20 (0.1 percent of GDP).
  - Losses NPR 4.9 billion in FY2020/21 (0.11 percent of GDP).
  - Loss reduced to NPR 2.8 billion in FY2021/22 (0.06 percent of GDP).
  - NAC’s liabilities exceeded total assets since FY2020/21, resulting in negative equity worsening in FY2021/22.
- Government credit risk exposure to NAC by end-FY2021/22:
  - Outstanding loans: NPR 3.6 billion (0.1 percent of GDP).
  - Debt guarantees: NPR 34 billion (0.7 percent of GDP).
  - Loans from nonbank financial institutions as of FY2021/22 exceeded their initial values, suggesting servicing difficulties.

### Nepal Electricity Authority (NEA): performance, concessions, and risks
- Pandemic effects:
  - Core businesses (generation, transmission, distribution) less sensitive to pandemic; main channel was shrinking electricity demand during lockdown.
  - Government introduced free electricity to households consuming up to 10 units per month with 5-ampere meters in FY2020/21; extended to up to 20 units per month in late 2021.
  - These discounted/free electricity arrangements are not compensated by the budget.
- FY2021/22 forgone revenue from free electricity:
  - Units distributed free: 85.99 million units.
  - Estimated forgone revenue: about NPR 558.9 million (0.01 percent of GDP).
- Financial performance:
  - FY2021/22 total profits: NPR 16.1 billion (0.3 percent of GDP) — historic high due to strong electricity demand amid fuel price surge.
  - Thermal power plants capacity: 8.1 percent of total electricity generation capacity.
- Debt and solvency indicators:
  - Debt to EBITDA declined from 24.3 in FY2018/19 to 17.1 by end-FY2021/22; threshold for high-risk category is five (SOE-HCT).
  - NEA classified in highest risk category for debt to EBITDA and debt coverage indicators.
  - Unfunded liabilities (mainly pension liabilities) increased to 0.7 percent of GDP by end-FY2020/21.
  - Liquidity management concerns: debtor turnover days and creditor turnover days classified in highest risk category.
- Power Purchase Agreements (PPAs) and capacity risks:
  - Signed PPAs by end-FY2021/22: 357 PPAs; combined installed capacity: 6,366 MW.
  - Additional PPA applications: 269 applications with total capacity 11,740 MW → potential total capacity 18,106 MW.
  - Electricity demand forecast ranges (Water and Energy Commission Secretariat’s Electricity Demand Forecast Report 2015-2040):
    - 2025: 5,787 MW - 10,803 MW.
    - 2030: 8,937 MW - 18,371 MW.
    - 2040: 19,151 MW - 51,330 MW.
  - If electricity demand falls short of expectations, NEA may incur losses from take-or-pay PPA commitments.

### Fiscal impact of shocks through public enterprises (PEs)
- Channels of fiscal impact:
  - Revenue side: deteriorating PE performance → lower dividends, royalties, taxes.
  - Expenditure side: higher subsidies, loans, equity injections, guarantees called, or debt takeover.
- Early pandemic (FY2019/20) snapshot:
  - Income tax contributed by PEs increased close to 0.1 percentage point of GDP.
  - Dividends increased a little more than 0.1 percentage point of GDP.
  - Fertilizer subsidies increased close to 0.1 percentage point of GDP.
  - Net above-the-line impact of pandemic through PEs (compared to FY2018/19): positive 0.1 percent of GDP.
  - Share investment and loan investment to PEs fell by 1 percentage point of GDP in FY2019/20.
- Subsequent fiscal deterioration (FY2020/21 and FY2021/22):
  - PEs’ contribution to fiscal revenue (income tax and dividends) declined by 0.16 percentage point of GDP in FY2020/21 and 0.23 percentage point of GDP in FY2021/22 (compared with FY2018/19).
  - Fiscal subsidies to PEs increased by 0.1 percentage point of GDP in each of FY2020/21 and FY2021/22.
  - Overall fiscal costs added to deficits: 0.26 percentage point of GDP in FY2020/21 and 0.32 percentage point of GDP in FY2021/22.
  - Government purchased 0.14 percent of GDP in NOC loans in FY2021/22.
- Government credit exposure to PEs:
  - Government loans to the PE sector by end-FY2020/21: NPR 252.6 billion (5.9 percent of GDP) — 0.9 percentage point of GDP higher than FY2018/19.
  - Outstanding guarantees to NAC: NPR 34 billion (0.7 percent of GDP).
  - Around 80 percent of government loans go to NEA, which is profitable, containing risk of large-scale default.

### Deposit and Credit Guarantee Fund (DCGF): guarantees, capacity, and fiscal risk
- Role and pandemic effects:
  - DCGF provides deposit insurance and credit guarantees to member banks and runs a credit guarantee program for poor, underserved and deprived sectors.
  - Average credit guarantee amount increased by 148.1 percent between mid-July 2021 to mid-January 2023 relative to mid-July 2018 to mid-July 2021 (pre-COVID period).
  - Average increase in claims paid to banks: 48 percent.
- Size and coverage:
  - Credit guarantee fund size: NPR 3.55 billion (less than 0.1 percent of FY2022/23 GDP).
  - Total guaranteed credit amount: NPR 265.28 billion (4.9 percent of FY2022/23 GDP).
  - Fund corresponds to 1.34 percent of the total guaranteed credit amount.
  - Concessional loans within guaranteed amount: 62 billion (1.1 percent of FY2022/23 GDP).
- Vulnerabilities and potential fiscal exposure:
  - No target size for the credit guarantee fund.
  - Major concessional loan items: agriculture, tourism and women entrepreneur loans (>90 percent of concessional guaranteed amount).
  - The 5-year maturity of concessional loan facility has not yet elapsed, but banks’ claims on these loans are expected to be significant.
  - Given total guaranteed amount of concessional loans is 1.1 percent of GDP as of mid-January 2023, repayment of claims corresponding to more than 5.7 percent of the guaranteed amount would exhaust the current credit guarantee fund.
  - Rising NPL levels suggest bank claims on other guaranteed loans (especially microfinance and SME sectors) may increase.
  - Recovery rates after reimbursement are on average below 0.01 percent, indicating significant moral hazard.
- Selected program parameters (as reported):
  - Micro Finance and Deprived Sector Credit Guarantee: Guarantee Limit up to Rs. 1.5 million; Guarantee Fee 1% p.a. (75% subsidy from government); Compensation 75 percent.
  - Agricultural Credit Guarantee: Guarantee Limit up to Rs 20. Million; Guarantee Fee 0.6% p.a. (50% subsidy); Compensation 70 - 80 percent.
  - Educational Credit Guarantee: Rs 1 million; Educated Unemployment Business Credit Guarantee: Rs 0.5 million; Guarantee Fee 1% p.a. (80% subsidy); Compensation 80 percent.
  - Small and Medium Enterprises Credit Guarantee: Up to Rs 20 million; Guarantee Fee 0.6% p.a. (50% subsidy); Compensation 70 – 80 percent.
  - Livestock Guarantee: For large livestock – Rs 0.15 million; For small livestock – Rs 30,000; Guarantee Fee 6% p.a. (75% subsidy); Compensation 90 (death) / 50 (unproductive).
  - Export Credit Guarantee: Up to Rs. 1 million; Guarantee Fee 1% p.a. (50% subsidy); Compensation 70-80 percent.

*Source: Excerpt from the provided IMF Nepal chapter PDF content.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1nplea2023002.pdf_