## 1nplea2023004 ## Source details **Canonical URL:** [1nplea2023004](https://www.imf.org/-/media/files/publications/cr/2023/english/1nplea2023004.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2023/english/1nplea2023004.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2023/english/1nplea2023004.pdf.json) --- ### Executive summary and program developments - ECF arrangement approved January 12, 2022: SDR 282.42 million (180 percent of quota or about US$ 376.5 million). - Disbursement: tranche of SDR 39.20 million (about US$ 52.25 million) brings total ECF budget support disbursements to SDR 166.90 million (about US$ 222.5 million). - Program performance: - All but one quantitative metrics met. - Performance criteria (PCs) on net international reserves and external arrears: met. - Indicative target (IT) on the primary deficit: met. - IT on child spending: missed by a slim margin (missed by 3 percent of the target or 0.004 percent of GDP in one test). - All standard continuous PCs: met. - Structural reform progress: five out of seven structural benchmarks completed (four met), two reset. ### Recent macroeconomic developments — growth, inflation, external sector, fiscal, and financial - Growth (real GDP growth, annual percent change): -2.4 (2019/20), 4.8 (2020/21), 5.6 (2021/22), 0.8 (2022/23 est.), 3.5 (2023/24 proj.), 5.2 (2024/25 proj.), 5.2 (2025/26 proj.), 5.2 (2026/27 proj.), 5.2 (2027/28 proj.). - Inflation (headline CPI, period average): 6.1 (2019/20), 3.6 (2020/21), 6.3 (2021/22), 7.8 (2022/23), 7.3 (2023/24), 6.2 (2024/25), 5.5 (2025/26), 5.4 (2026/27), 5.4 (2027/28). - Inflation (headline CPI, end of period): 4.8 (2019/20), 4.2 (2020/21), 8.1 (2021/22), 7.4 (2022/23), 6.8 (2023/24), 5.5 (2024/25), 5.4 (2025/26), 5.4 (2026/27), 5.4 (2027/28). - Inflation was 8.2 percent in September 2023; headline inflation stood at 7.5 percent in mid-October 2023. - External sector and reserves: - Workers' remittances (US$ millions): 7,533 (2019/20), 8,150 (2020/21), 8,326 (2021/22), 9,330 (2022/23), 9,967 (2023/24), 10,356 (2024/25), 10,811 (2025/26), 11,341 (2026/27), 11,891 (2027/28). - Workers' remittances (% of GDP): 22.5 (2019/20), 22.1 (2020/21), 20.4 (2021/22), 22.7 (2022/23), 21.7 (2023/24), 20.3 (2024/25), 19.3 (2025/26), 18.4 (2026/27), 17.5 (2027/28). - Gross official reserves (US$ millions): 10,559 (2019/20), 10,884 (2020/21), 8,953 (2021/22), 10,916 (2022/23), 12,674 (2023/24), 13,225 (2024/25), 14,186 (2025/26), 15,134 (2026/27), 16,125 (2027/28). - Gross official reserves (months of prospective imports): 9.0 (2019/20), 7.5 (2020/21), 7.6 (2021/22), 8.3 (2022/23), 8.4 (2023/24), 8.3 (2024/25), 8.4 (2025/26), 8.4 (2026/27), 8.4 (2027/28). - Current account (US$ millions): -339 (2019/20), -2,844 (2020/21), -5,174 (2021/22), -586 (2022/23), -721 (2023/24), -2,015 (2024/25), -1,903 (2025/26), -2,032 (2026/27), -2,132 (2027/28). - Current account (% of GDP): -1.0 (2019/20), -7.7 (2020/21), -12.7 (2021/22), -1.4 (2022/23), -1.6 (2023/24), -4.0 (2024/25), -3.4 (2025/26), -3.3 (2026/27), -3.1 (2027/28). - Financial sector and credit: - Credit growth dropped from exceeding 30 percent in FY2021/22 to low single digits in FY2022/23. - NPLs for commercial banks rose from 1.3 percent in June 2022 to 3.0 percent as of August 2023; bank-reported NPLs increased from 1.7 percent in August 2022 to 3.0 percent in August 2023 in other summaries. - Broad money (annual percent change): 18.1 (2019/20), 21.8 (2020/21), 6.8 (2021/22), 11.4 (2022/23), 10.4 (2023/24), 11.7 (2024/25), 11.0 (2025/26), 10.9 (2026/27), 10.6 (2027/28). - Domestic credit (annual percent change): 14.6 (2019/20), 26.8 (2020/21), 17.9 (2021/22), 8.8 (2022/23), 11.3 (2023/24), 11.2 (2024/25), 11.1 (2025/26), 10.9 (2026/27), 10.9 (2027/28). - Private sector credit (annual percent change): 12.6 (2019/20), 26.3 (2020/21), 13.3 (2021/22), 4.6 (2022/23), 8.6 (2023/24), 8.8 (2024/25), 9.5 (2025/26), 10.2 (2026/27), 10.9 (2027/28). - Fiscal outcomes: - FY2022/23 net lending/borrowing (central government): -5.8 percent of GDP. - Total revenue and grants (% of GDP): 22.2 (2019/20), 23.3 (2020/21), 23.1 (2021/22), 19.3 (2022/23), 19.8 (2023/24), 20.8 (2024/25), 21.5 (2025/26), 22.1 (2026/27), 22.8 (2027/28). - Tax revenue (% of GDP): 18.0 (2019/20), 20.0 (2020/21), 20.0 (2021/22), 16.1 (2022/23), 16.5 (2023/24), 17.6 (2024/25), 18.4 (2025/26), 19.1 (2026/27), 19.7 (2027/28). - Expenditure (% of GDP): 27.6 (2019/20), 27.2 (2020/21), 26.3 (2021/22), 25.1 (2022/23), 25.1 (2023/24), 25.4 (2024/25), 25.5 (2025/26), 25.7 (2026/27), 25.8 (2027/28). - Primary deficit (% of GDP): 4.7 (2019/20), 3.2 (2020/21), 2.2 (2021/22), 4.4 (2022/23), 3.6 (2023/24), 2.9 (2024/25), 2.3 (2025/26), 1.8 (2026/27), 1.3 (2027/28). - Public debt (% of GDP): 43.3 (2019/20), 43.3 (2020/21), 43.1 (2021/22), 47.0 (2022/23), 48.4 (2023/24), 49.3 (2024/25), 50.0 (2025/26), 50.2 (2026/27), 50.0 (2027/28). - Nominal GDP (US$ billions): 33.4 (2019/20), 36.9 (2020/21), 40.8 (2021/22), 41.0 (2022/23), 45.9 (2023/24), 50.9 (2024/25), 56.1 (2025/26), 61.7 (2026/27), 67.8 (2027/28). - Tax revenue (NPR billions): 700 (2019/20), 870 (2020/21), 984 (2021/22), 866 (2022/23), 986 (2023/24), 1,173 (2024/25), 1,357 (2025/26), 1,560 (2026/27), 1,790 (2027/28). - Other indicators: - Trade balance (US$ millions): -9,186 (2019/20), -11,510 (2020/21), -13,759 (2021/22), -10,728 (2022/23), -11,813 (2023/24), -13,735 (2024/25), -14,337 (2025/26), -15,230 (2026/27), -16,113 (2027/28). - Net international reserves (US$ millions): 10,291 (2019/20), 10,620 (2020/21), 8,821 (2021/22), 10,473 (2022/23), 12,146 (2023/24), 12,623 (2024/25), 13,589 (2025/26), 14,590 (2026/27), 15,644 (2027/28). - Exchange rate (NPR/US$, period average): 116.3 (2019/20), 117.9 (2020/21), 120.8 (2021/22), 130.8 (2022/23). ### Outlook and risks - Growth outlook: - Growth expected to recover to 3.5 percent in FY2023/24, below potential, driven by increased domestic demand, new hydroelectric capacity, and recovery in tourism. - Model-based nowcasts/projections: GDP growth in basic prices FY2022/23 expected in the region of 1 percent; FY2023/24 expected range 5.8-6.0 percent in the Annex model; other institutional projections show 3.5 percent for FY2023/24. - Current account: - CA deficit excluding grants expected to widen to 2.5 percent of GDP in FY2023/24; including grants projected at 1.6 percent of GDP in FY2023/24. - Reserves and financing: - Reserve coverage projected to remain stable and above estimated adequacy levels through the medium term. - Imports projected to rebound strongly in FY2024/25 in line with growing capital expenditure. - Downside risks (skewed to the downside): - External: higher commodity prices; growth slowdown in partner economies; large decline in remittances. - Domestic: further bank balance sheet deterioration; low execution of capital projects; lack of progress on APG/FATF deficiencies. - Natural disasters and climate shocks (example: 6.4 magnitude earthquake on November 3, 2023, estimated to have caused more than 150 deaths and 300 injuries). - Fragile social or political stability disrupting policy continuity. ### Policy recommendations — fiscal, monetary/financial, governance, structural - Fiscal policy: - Focus on gradual, growth-friendly fiscal consolidation while enhancing capital spending and supporting the most vulnerable. - Maintain momentum on governance reforms to cement gains in fiscal transparency. - Further mobilize domestic revenue: improve VAT, personal and corporate income taxes, excises, and property tax. - Guide reforms with a comprehensive domestic revenue mobilization strategy (end-April 2024 SB). - Ensure contingency planning for natural disasters; maintain child grant spending and aim to expand coverage from 25 districts to all 77 districts. - Monetary and financial sector policies: - Maintain cautious, data-dependent monetary policy to preserve price and external stability while monetary transmission remains weak. - Avoid further boom-bust credit cycles; establish stable pro-growth financial sector equilibrium. - Continue reforms on lending practices and asset classification; proceed with loan portfolio review (LPR) of the ten largest banks (LPR completion by end-December 2024 SB; roadmap by end-February 2025 SB). - Improve NRB monetary policy toolkit to absorb surplus liquidity; planned Standing Deposit Facility by January 2024 noted. - Continue implementation of financial sector reform agenda to align with international standards (Basel III LCR/NSFR plans; transition to expected credit loss provisioning in 2024). - Governance and AML/CFT: - Urgently improve AML/CFT framework to address APG deficiencies; enact “Amendments to Some Laws relating to AML and Business Promotion Bill” (new end-July 2024 SB). - Implement 2021 IMF Safeguards Assessment recommendations regarding the NRB Act and NRB audits (submit NRB Act amendments to Parliament by end-April 2024; external audit with international experts end-July 2024). - Strengthen public enterprise transparency: require all majority- and wholly-owned PEs to publish FY2022/23 annual financial statements (modified and reset to end-August 2024); audit FY2022/23 financial statements of four priority nonfinancial PEs (reset to end-August 2024). - Public investment and PFM: - Develop comprehensive public investment management reform action plan (end-April 2024 SB). - Expand fiscal risk registry to include subnational governments and PPPs; publish comprehensive fiscal risk statement with the FY2025/26 budget (new end-August 2025 SB). - Improve cash flow forecasting and Treasury Single Account coordination (end-September 2023 SB, met). - Social safety nets and structural reforms: - Continue reforms to improve business climate, reduce cost of doing business, build human capital, and enhance social safety nets. - Expand child grant coverage and improve targeting using National Social Registry and PIR. ### Financial sector stability and supervisory actions - NRB actions and timelines: - Issued asset classification regulation updates (published February and August 2023; end-August 2023 SB, met). - Issued and amended Working Capital Loan (WCL) guidelines (effective October 2022; amended January and August 2023). - Implemented Supervisory Information System (SIS) (excluding on-site module) for all banks (end-August 2023 SB, met); on-site module for Class A banks by end-April 2024 SB. - Introduced counter-cyclical capital buffer in July 2023, initially set at 0. - Discontinue option for banks to classify debentures as both deposits and capital by mid-January 2024. - Plan to implement Basel III liquidity coverage ratio and net stable funding ratio and to transition to expected credit loss provisioning approach in 2024. - Prepare and launch LPR for the ten largest banks (project team and Concept Note finalized; NRB to finalize Terms of Reference by end-December 2023; launch early next year; phased exercise using end-year data mid-July 2024). - Prudential metrics and concerns: - Nepal’s credit-to-GDP ratio near about 100 percent of GDP. - NPLs across banks almost doubled compared to July 2022 levels. - Banking system core capital eroded slowly from 10.8 to 10.6 (other excerpts show core capital at 10.1 in June 2023 before improving to 10.5 in August 2023). - NRB will conduct phased on-site in-depth inspections for the 10 largest banks assisted by independent international auditors (launch end-April 2024; complete by end-December 2024). - Financial cooperatives: - Over 14,000 saving and credit cooperatives exist and represent around 7 percent of total lending; some exceed the size of Class B and C banks. - Authorities intend to establish a specialized regulatory authority to regulate and supervise financial cooperatives with NRB technical assistance. ### Program modalities, conditionality changes, financing, and monitoring - Conditionality changes: - Primary deficit target (currently an IT) to become a quantitative PC at the January 14, 2024 test date. - Cap on the upward adjustment of the foreign-financed project loan adjustor on the primary deficit will be removed. - Revenue adjustor to the primary deficit proposed to be removed from the July 15, 2024 test date onwards. - An IT floor on tax revenue proposed to begin at the 5th review. - Capacity to repay and financing: - IMF credit outstanding projected to peak at 262.3 percent of quota in FY2024/25 (SDR 411.6 million), within the cumulative normal access limit. - This corresponds to 17.3 percent of exports and 1.2 percent of GDP. - Program fully financed with firm commitments in place for the next 12 months. - Key fiscal and external numbers (selected table highlights, in percent of GDP): - FY2023/24 / FY2024/25: External financing requirement: 0.4 / 2.7; Total revenue and grants: 19.8 / 20.8; Expenditure: 25.1 / 25.4; Current account deficit 1/: 2.5 / 4.8; Fiscal deficit: 5.3 / 4.6. - Financing commitments so far (by source, percent of GDP): IMF: ECF: 0.2 / 0.2; Asian Development Bank: 0.3 / 0.1; World Bank: 0.4 / 0.2. - Note: Current baseline forecast is as of September 28, 2023. Footnote: 1/ Current account excludes official transfers. - Program monitoring and reporting: - NIR targets are set as a floor with adjustors for budget support and revenue shortfalls; any downward adjustment capped at USD 710 million. - Primary deficit defined on cash basis; targets set as a ceiling for cumulative flows from end of previous fiscal year. - Primary deficit revenue shortfall adjustor capped at NPR 61,009 million for January 15, 2024. - Indicative targets on child grant spending set as a floor (activity codes 7.1.1.10, 7.1.1.41, 7.1.1.43). - Continuous PCs include prohibition on accumulation of new external payments arrears. - Detailed reporting calendar and data submission lags specified for MOF, PDMO, and NRB. ### Climate vulnerability, adaptation costs, and priorities - Climate shocks impacts: - Floods, landslides, droughts, and storms generated GDP losses of 2.3 percent (annual basis). - Welfare losses for the average household from these shocks were 3.3 percent (annual basis). - These shocks increased the rate of undernourishment by 2.8 percent (annual basis). - Severe climate change scenario could cause GDP to be 7 percent lower by 2050. - National Adaptation Plan (NAP, 2021) and 16th Plan: - NAP costed priority climate adaptation programs across agriculture and food security; industry, transport, and physical infrastructure; disaster risk reduction and management. - Implementing the NAP in full estimated cost: USD 47.4 billion until 2050. - Policy recommendation: combine reform agenda with concessional climate finance; apply Climate-PIMA (2021) recommendations. - Recommended actions: - Prioritize disaster prevention, financial/economic stability responses to shocks, and mitigation consistent with Nepal’s Net Zero by 2045 commitment. ### Annex I — Drivers and Dynamics of Growth (modeling and nowcasts) - Data and approach: - Quarterly real GDP growth series Q1 2011–Q2 2023 (46 quarters) used with high-frequency domestic and external variables. - OLS specifications with proxies for investment, input costs, external sector, and lagged GDP terms; general-to-specific modelling and four sample specifications to handle large shocks. - Preferred parsimonious model (model 4): - Explains 81 percent of variation (푅푅2 = 81 percent). - Most significant correlates: India’s GDP growth, domestic credit growth, import growth. - Magnitudes: 1pp higher growth in India correlates with 0.4pp higher growth in Nepal; 1pp higher domestic credit growth correlates with 0.08pp higher growth in Nepal; 1pp higher import growth correlates with 0.07pp higher growth in Nepal. - Four-quarter lagged GDP is a strong negative impulse on growth. - Nowcast/projection outcomes from model: - GDP growth in basic prices FY2022/23 expected in the region of 1 percent. - GDP growth in FY2023/24 expected range 5.8-6.0 percent by the model; other projections emphasize a rebound to 3.5 percent in FY2023/24. - Limitations and downside risks: - Small sample, limited statistical power, potential instability during shock periods. - Growth may undershoot if India’s growth relationship weakens, credit growth and imports do not rebound, or balance sheet repair constrains lending. ### Program decision, disbursement request, and staff assessment - Staff supports completion of the third review and disbursement of fourth tranche: SDR 39.2 million. - Phasing table notes Third Review: November 1, 2023 — Observance of performance criteria on Jul 16, 2023 — 39.20 SDR Million, 25% of quota. Nepal's quota: SDR 156.9 million. - Staff appraisal summary: - Growth projected to recover to 3.5 percent in FY2023/24. - Balance sheet repair after post-pandemic boom-bust cycle impeding growth. - Program performance: all but one quantitative metrics met; five of seven SBs completed (four met). - Policy priorities reiterated: fiscal consolidation while protecting capital and vulnerable groups; cautious, data-driven monetary policy; implement Safeguards Assessment and AML/CFT reforms; continue governance and structural reforms. *Source: NEPAL — THIRD REVIEW UNDER THE EXTENDED CREDIT FACILITY ARRANGEMENT (IMF staff report, November 10, 2023) and related IMF country documents included in content unit 1nplea2023004.* ### 39.20 million (about US$ 52.25 million). This brings total disbursements under the ECF for ### 1nplea2023004 - 39.20 million (about US$ 52.25 million). This brings total disbursements under the ECF for ### Executive summary and program developments - The ECF arrangement for Nepal was approved by the Executive Board on January 12, 2022 in an amount equivalent to SDR 282.42 million (180 percent of quota or about US$ 376.5 million). - The tranche of SDR 39.20 million (about US$ 52.25 million) brings total disbursements under the ECF for budget support thus far to SDR 166.90 million (about US$ 222.5 million). - Program performance: all but one quantitative metrics met. Performance criteria (PCs) on net international reserves and external arrears were met; the indicative target (IT) on the primary deficit was met; the IT on child spending was missed by a slim margin. All standard continuous PCs were met. - Structural reform progress: five out of seven structural benchmarks completed (four met), two reset. ### Recent developments - Growth and inflation - Real GDP growth: -2.4 (2019/20), 4.8 (2020/21), 5.6 (2021/22), 0.8 (2022/23 est.), 3.5 (2023/24 proj.), 5.2 (2024/25 proj.), 5.2 (2025/26 proj.), 5.2 (2026/27 proj.), 5.2 (2027/28 proj.). - Headline CPI (period average): 6.1 (2019/20), 3.6 (2020/21), 6.3 (2021/22), 7.8 (2022/23), 7.3 (2023/24), 6.2 (2024/25), 5.5 (2025/26), 5.4 (2026/27), 5.4 (2027/28). - Headline CPI (end of period): 4.8 (2019/20), 4.2 (2020/21), 8.1 (2021/22), 7.4 (2022/23), 6.8 (2023/24), 5.5 (2024/25), 5.4 (2025/26), 5.4 (2026/27), 5.4 (2027/28). - Inflation was 8.2 percent in September 2023. - External sector and reserves - Workers' remittances (in millions of U.S. dollars): 7,533 (2019/20), 8,150 (2020/21), 8,326 (2021/22), 9,330 (2022/23), 9,967 (2023/24), 10,356 (2024/25), 10,811 (2025/26), 11,341 (2026/27), 11,891 (2027/28). - Workers' remittances (in percent of GDP): 22.5 (2019/20), 22.1 (2020/21), 20.4 (2021/22), 22.7 (2022/23), 21.7 (2023/24), 20.3 (2024/25), 19.3 (2025/26), 18.4 (2026/27), 17.5 (2027/28). - Gross official reserves (in millions of U.S. dollars): 10,559 (2019/20), 10,884 (2020/21), 8,953 (2021/22), 10,916 (2022/23), 12,674 (2023/24), 13,225 (2024/25), 14,186 (2025/26), 15,134 (2026/27), 16,125 (2027/28). - Gross official reserves in months of prospective imports: 9.0 (2019/20), 7.5 (2020/21), 7.6 (2021/22), 8.3 (2022/23), 8.4 (2023/24), 8.3 (2024/25), 8.4 (2025/26), 8.4 (2026/27), 8.4 (2027/28). - Current account (in millions of U.S. dollars): -339 (2019/20), -2,844 (2020/21), -5,174 (2021/22), -586 (2022/23), -721 (2023/24), -2,015 (2024/25), -1,903 (2025/26), -2,032 (2026/27), -2,132 (2027/28). - Current account in percent of GDP: -1.0 (2019/20), -7.7 (2020/21), -12.7 (2021/22), -1.4 (2022/23), -1.6 (2023/24), -4.0 (2024/25), -3.4 (2025/26), -3.3 (2026/27), -3.1 (2027/28). - Financial sector and credit - Credit growth dropped from exceeding 30 percent in FY2021/22 to low single digits in FY2022/23. - NPLs for commercial banks rose from 1.3 percent in June 2022 to 3.0 percent as of August 2023. - Broad money (annual percent change): 18.1 (2019/20), 21.8 (2020/21), 6.8 (2021/22), 11.4 (2022/23), 10.4 (2023/24), 11.7 (2024/25), 11.0 (2025/26), 10.9 (2026/27), 10.6 (2027/28). - Domestic credit (annual percent change): 14.6 (2019/20), 26.8 (2020/21), 17.9 (2021/22), 8.8 (2022/23), 11.3 (2023/24), 11.2 (2024/25), 11.1 (2025/26), 10.9 (2026/27), 10.9 (2027/28). - Private sector credit (annual percent change): 12.6 (2019/20), 26.3 (2020/21), 13.3 (2021/22), 4.6 (2022/23), 8.6 (2023/24), 8.8 (2024/25), 9.5 (2025/26), 10.2 (2026/27), 10.9 (2027/28). - Fiscal outcomes - Fiscal year FY2022/23 net lending/borrowing (central government) was -5.8 percent of GDP. - Total revenue and grants (in percent of GDP): 22.2 (2019/20), 23.3 (2020/21), 23.1 (2021/22), 19.3 (2022/23), 19.8 (2023/24), 20.8 (2024/25), 21.5 (2025/26), 22.1 (2026/27), 22.8 (2027/28). - Tax revenue (in percent of GDP): 18.0 (2019/20), 20.0 (2020/21), 20.0 (2021/22), 16.1 (2022/23), 16.5 (2023/24), 17.6 (2024/25), 18.4 (2025/26), 19.1 (2026/27), 19.7 (2027/28). - Expenditure (in percent of GDP): 27.6 (2019/20), 27.2 (2020/21), 26.3 (2021/22), 25.1 (2022/23), 25.1 (2023/24), 25.4 (2024/25), 25.5 (2025/26), 25.7 (2026/27), 25.8 (2027/28). - Primary deficit (in percent of GDP): 4.7 (2019/20), 3.2 (2020/21), 2.2 (2021/22), 4.4 (2022/23), 3.6 (2023/24), 2.9 (2024/25), 2.3 (2025/26), 1.8 (2026/27), 1.3 (2027/28). - Public debt (in percent of GDP): 43.3 (2019/20), 43.3 (2020/21), 43.1 (2021/22), 47.0 (2022/23), 48.4 (2023/24), 49.3 (2024/25), 50.0 (2025/26), 50.2 (2026/27), 50.0 (2027/28). - Nominal GDP (in billions of U.S. dollars): 33.4 (2019/20), 36.9 (2020/21), 40.8 (2021/22), 41.0 (2022/23), 45.9 (2023/24), 50.9 (2024/25), 56.1 (2025/26), 61.7 (2026/27), 67.8 (2027/28). - Tax revenue (in billions of Nepalese Rupees): 700 (2019/20), 870 (2020/21), 984 (2021/22), 866 (2022/23), 986 (2023/24), 1,173 (2024/25), 1,357 (2025/26), 1,560 (2026/27), 1,790 (2027/28). - Other indicators - Trade balance (in millions of U.S. dollars): -9,186 (2019/20), -11,510 (2020/21), -13,759 (2021/22), -10,728 (2022/23), -11,813 (2023/24), -13,735 (2024/25), -14,337 (2025/26), -15,230 (2026/27), -16,113 (2027/28). - Net international reserves (in millions of U.S. dollars): 10,291 (2019/20), 10,620 (2020/21), 8,821 (2021/22), 10,473 (2022/23), 12,146 (2023/24), 12,623 (2024/25), 13,589 (2025/26), 14,590 (2026/27), 15,644 (2027/28). - Exchange rate (NPR/US$; period average): 116.3 (2019/20), 117.9 (2020/21), 120.8 (2021/22), 130.8 (2022/23). ### Outlook and risks - Growth outlook - Growth is expected to recover to 3.5 percent in FY2023/24, which is below potential, driven by increased domestic demand, new hydroelectric capacity, and a continued recovery in tourism. - Risk assessment - Risks are skewed to the downside. - External sector risks dominate due to high remittance income and dependence on imported goods. - Domestic risks include further deterioration in bank balance sheets and lack of progress addressing deficiencies identified by the Asia Pacific Group of the FATF, which could create financial system stress. ### Policy recommendations - Fiscal policy - Focus on gradual, growth-friendly fiscal consolidation while enhancing capital spending and supporting the most vulnerable to ensure medium-term fiscal sustainability. - Maintain momentum on governance reforms to cement gains in fiscal transparency. - Further structural reforms needed to mobilize domestic revenue, strengthen public investment management, and address fiscal risks. - Monetary and financial sector policies - Maintain the current cautious, data-dependent monetary policy to preserve price and external stability while monetary policy transmission remains weak. - Financial policy should remain vigilant to avoid further boom-bust credit cycles and to establish a more stable, pro-growth financial sector equilibrium. - Continue reforms on lending practices and asset classification and proceed with the loan portfolio review of the ten largest banks. - Continue implementation of the financial sector reform agenda to align the local framework more closely to international standards. - Governance and structural reforms - Improve the anti-money laundering/combating the financing of terrorism (AML/CFT) framework and its effectiveness in line with international standards and peer evaluations to maintain smooth access to the global financial system. - Implement the 2021 IMF Safeguards Assessment recommendations regarding the Nepal Rastra Bank (NRB) Act and NRB audit as a priority. - Continue reforms to improve the business climate, build human capital, and enhance social safety nets, particularly expanding coverage of the child grant program. ### Program modalities and technical notes - Note: Fiscal year ends in mid-July. - Note: The NSO adopts a 3 year cycle in its national accounts producing preliminary, revised and final estimates for real GDP growth. In May 2023 growth was revised up in FY2021/22 from 4.2 percent to 4.8 percent and from 5.3 percent to 5.6 percent in FY2021/22 in light of new data. - Note: Current baseline forecast is as of September 28, 2023. *Source: NEPAL — THIRD REVIEW UNDER THE EXTENDED CREDIT FACILITY ARRANGEMENT (IMF staff report, November 10, 2023).* ### 4. A modest growth pickup is projected in FY2023/24, and the medium-term outlook ### 4. A modest growth pickup is projected in FY2023/24, and the medium-term outlook remains favorable ### Outlook and key macro projections - Growth is expected to recover to 3.5 percent in FY2023/24—despite the November 2023 earthquake in western Nepal—led by increased domestic demand, new hydroelectric capacity, and a continued recovery in tourism, but to remain below potential. - The recent uptick in food prices is expected to abate with the upcoming regional harvest. - Disinflation in India would help bring down Nepal’s inflation towards the NRB’s target of 6.5 percent by the end of FY2023/24. - The current account (CA) deficit excluding grants is expected to widen to 2.5 percent of GDP in FY2023/24. - Including grants, the current account deficit is projected at almost the same level as in FY2022/23 (1.6 percent of GDP), helped by a grant from the Millennium Challenge Corporation. - A gradual increase in FDI and other investment is expected to finance the CA deficit; reserve coverage is projected to remain stable and above estimated adequacy levels through the medium term. - Imports are projected to rebound strongly in FY2024/25 in line with growing capital expenditure and a rebound in GDP growth. - Example of recent natural disaster: a 6.4 magnitude earthquake struck western Nepal on November 3, 2023, estimated to have caused more than 150 deaths and 300 injuries. ### Downside risks - External risks: - Higher commodity prices would slow recovery in energy-intensive sectors, aggravate food insecurity, and impose fiscal costs. - A growth slowdown in partner economies would weigh on incomes of Nepalese workers abroad, stall the recovery in tourism, and slow exports. - Domestic risks: - Continued lower execution of capital projects, more subdued demand for credit, or more extensive balance sheet repair would depress domestic demand and economic activity. - The budget’s low credibility reduces its influence on actual execution, raising uncertainty about fiscal outcomes. - Lack of progress on Asia Pacific Group/FATF deficiencies could lead to severe reputational costs, hinder access to the global financial system, raise financial transaction costs, and increase risks to financial stability. - A further rise in NPLs could raise concerns about bank capital adequacy ratios. - Fragile social or political stability could disrupt policy continuity and reform implementation. - Nepal remains vulnerable to natural disasters and climate shocks. ### Program performance and reform progress - Program performance: - The performance criterion (PC) on net international reserves (floor) was met comfortably; the external arrears PC was also met. - The indicative target (IT) on the primary fiscal deficit (ceiling) was met, aided by spending discipline of the midterm budget review and the revenue adjustor amid a large revenue shortfall. - The IT on child grant spending (floor) was marginally missed by 3 percent of the target or 0.004 percent of GDP. - All standard continuous PCs were met. - Structural benchmarks (SBs): - Of seven SBs, four were met (fiscal risk registry, cash-flow forecasting, issuance of amendments to the asset classification regulation, supervisory information system). - One SB (publication of non-customs tax exemptions) was completed with delay. - Two SBs (reporting consolidated financial statements; submission of NRB Act amendments to Parliament) were missed and are proposed to be reset. - The structural reform agenda was re-prioritized to reflect implementation capacity constraints and emerging short-term risks, notably AML/CFT; new SBs on AML/CFT were introduced while other SBs (reporting operational funds financial statements, publishing a tax expenditure report, auditing four key public enterprises, publishing PEs financial statements) were postponed. ### Safeguarding fiscal resilience (policy measures and recommendations) - FY2023/24 budget measures to address near-term fiscal pressures: - Establishing a 39 percent top income tax rate for income above NPR 5 million. - Increasing the tax rate for interest paid to bank depositors. - Removing VAT exemptions for 170 items. - Other excise duty measures expected to yield at least 0.4 percent of GDP in additional revenue. - Despite modest growth and y-o-y decline in domestic revenue in the first two months of the fiscal year, the fiscal deficit is projected to decline to 5.3 percent of GDP in FY2023/24. - The program objective: gradual fiscal consolidation to stabilize public debt at a low risk of distress, even though the debt-to-GDP ratio is expected to rise slightly through FY2026/27. - The debt-service-to-revenue ratio would reach 40 percent in 2023/24 relative to about 25 percent in the May 2023 DSA before declining to 25 percent in the medium term. - Policy recommendations to achieve growth-friendly consolidation: - Further mobilize domestic revenue by improving VAT, personal and corporate income taxes, excises, and property tax. - Guide reforms with a comprehensive domestic revenue mobilization strategy (end-April 2024 SB). - Enhance estimates of custom duty exemptions and non-customs-related tax exemptions and prepare/publish a comprehensive tax expenditures report (end-April 2024 SB, reset for end-January 2025). - Continue rationalizing spending duplication with subnational governments. - Maintain child grant spending in FY2023/24 and endeavor to extend coverage from 25 districts to all 77 districts. - Ensure contingency planning to respond quickly to natural disasters, including earthquakes. - Further actions to boost capital spending and investment efficiency: - Develop a comprehensive reform action plan to address weaknesses in public investment management (end-April 2024 SB). - Expand the fiscal risk registry to include subnational governments and PPPs; prepare and publish a comprehensive fiscal risk statement with the FY2025/26 budget (new end-August 2025 SB). - All majority- and wholly-owned public enterprises should publish FY2022/23 annual financial statements (end-April 2024 SB, modified and reset to end-August 2024). - Audit FY2022/23 financial statements of four priority nonfinancial PEs (end-April 2024 SB, reset to end-August 2024). - Reset reporting of extra-budgetary operational funds in annual financial statements to end-January 2025 to allow FCGO mapping of accrual accounts into consolidated cash-based accounts. - Continue improving realism of the initial budget, including revenue forecasts, building on the new cash flow forecasting framework (end-September 2023 SB, met). ### Preserving macroeconomic and financial stability (monetary and financial sector policies) - Monetary policy stance and performance: - The NRB eased monetary policy on July 23, 2023, through a 50-basis point cut in the context of rising reserves. - Credit growth has not yet responded despite the interbank rate falling below 2 percent, suggesting limited scope for monetary policy to boost growth. - The NRB should remain focused on price and external stability through cautious and data dependent monetary policy to avoid boom-bust cycles. - Prudent monetary policy, alongside the ECF arrangement and budget support from development partners, should continue to help build reserves without resorting to distortionary trade restrictions. - Need to expand NRB monetary policy implementation capacity: - The Finance Ministry’s change in the amount of funds local governments can place as commercial bank deposits shifted base money by roughly 7-9 percent, disrupting monetary policy. - Changes in local government deposit policy should be gradual, announced in advance, and coordinated with the NRB; the NRB should neutralize resulting excess liquidity because large deviations from the policy rate (over 400 basis points in mid-October 2023) undermine monetary policy credibility. - Further refinement of the monetary policy toolkit is required to keep rates inside the interest rate corridor; plans for a new facility to absorb liquidity at the bottom of the corridor are welcome. - Improved cash flow forecasting by the Finance Ministry (end-September 2023 SB, met) would aid coordination on use of the Treasury Single Account and help the NRB calibrate monetary operations. - Financial sector reforms to support sustainable credit growth: - Nepal’s credit to GDP ratio has almost doubled in recent years to about 100 percent of GDP. - NPLs across all types of banks almost doubled compared to the level in July 2022. - The banking system’s core capital position has slowly eroded from 10.8 to 10.6. - The NRB drafted and issued amendments to the asset classification regulations to tackle forbearance; these were published in February and August 2023 (end-August 2023 SB, met). - NRB issued guidelines to tighten the use of Working Capital Loans (WCL) to limit evergreening; guidelines effective since October 2022 were amended in January and August 2023. - Expected outcomes: better alignment of asset classifications and provisioning with international standards, more sustainable credit growth, and improved overview of loan portfolios prior to the loan portfolio review (LPR). - NRB actions to enhance supervision: - Implemented the Supervisory Information System (excluding on-site module) for all banks (end-August 2023 SB, met); on-site module for Class A Banks to be completed by end-April 2024 SB. - Introduced the counter-cyclical capital buffer in July 2023, initially set at 0. - Will discontinue the option for banks to classify debentures as both deposits and capital by mid-January 2024. - Plans to introduce Basel III liquidity coverage ratio and net stable funding ratio, and to transition banks to expected credit loss provisioning approach in 2024. - Further reforms to implement recommendations of the 2023 Financial Sector Stability Review (FSSR) are being considered. *International Monetary Fund* ### 16. The authorities need to continue enhancing policies to ensure a stable and ### 16. The authorities need to continue enhancing policies to ensure a stable and ### Banking system stability and monetary transmission - Continue assessing the impact of directed lending on banks’ business models and financial stability, closely monitor the quality of these loans, and review their amount as needed to help unlock further credit to the most bankable projects across sectors. - Monitor the impact of interest rate regulations on monetary policy transmission and bank viability and gradually move to more market-based determination of interest rates to improve transmission. - The NRB has started preparations for the portfolio review of the ten largest banks: - A project team and a Concept Note outlining the main elements of the LPR have been finalized. - The NRB will launch the exercise early next year (end-April 2024 SB). - The exercise is expected to be phased to allow use of end-year data (mid-July 2024). - NRB will finalize the Terms of Reference for the exercise by end-December 2023. - Two new SBs were agreed: completion of the LPR by end-December 2024 and finalizing a roadmap outlining the NRB’s approach to the outcome by end-February 2025. ### Financial cooperatives and supervision - Over 14,000 saving and credit cooperatives exist and represent around 7 percent of total lending; some exceed the size of Class B and C banks. - These cooperatives are regulated by the Department of Cooperatives or local authorities without the necessary data to assess risks. - The “Amendments to Some Laws relating to AML and Business Promotion Bill” will expand oversight and data collection in this area. - Authorities intend to establish and operationalize a specialized regulatory authority to regulate and supervise financial cooperatives, with technical assistance from the NRB and incorporating FSSR recommendations. - The NRB will closely collaborate on the supervision of systemically important financial cooperatives. ### Governance, safeguards, and audits - Most of the 2021 safeguards assessment (SGA) recommendations remain outstanding; progress on recommendations related to governance, internal audit and controls in key operations has been limited. - Footnote: 5 out of 16 recommendations have been implemented, the other recommendations are in progress. - The FY2022/23 financial statements audit is underway without participation of auditors with international experience in auditing central banks. The FY2023/24 audit will involve auditors with such experience (new end-July 2024 SB). - Fund staff provided advice to modernize the NRB Act to strengthen mandate, autonomy, and governance. Draft amendments address some vulnerabilities but materially deviate from SGA recommendations. - Authorities should continue engaging with Fund staff to further align the amendment bill with the SGA recommendations before submitting it to Parliament (end-August 2023 SB, reset to end-April 2024). ### AML/CFT urgency - The Asia/Pacific Group on Money Laundering (APG) assessment determined Nepal will enter the International Co-operation Review Group (ICRG) observation period and must implement necessary reforms within one year to avoid possible public identification and formal FATF review. - Deficiencies could lead to severe reputational and financial stability risks, negatively impacting correspondent banking relationships, access to the global financial network, and raising financial transaction costs. - Authorities will enact the “Amendments to Some Laws relating to AML and Business Promotion” Bill to improve compliance with international standards and address gaps, with TA support from the Fund and other development partners (new end-July 2024 SB). - Strengthening the AML/CFT framework is described as “a top and urgent priority.” ### Structural reforms, social safety nets, and growth constraints - Structural barriers to growth: high cost of doing business; weak governance and anti-corruption institutions; low human capital and productivity; regulatory restrictions to foreign investments; low FDI flows compared to peers. - Capital expenditure on growth-enhancing infrastructure consistently underperforms budgeted amounts. - Government plans to release the 16th Development Plan in February 2024 to guide policy from FY 2024/25 to FY 2028/29 on investment, climate adaptation, social justice, and employment. - Social safety net spending skewed towards pensions. The child grant covers children 0-5 years old in 25 of the poorest districts and Dalit children nationwide, but the size is small: NPR 532 per month per child and does not adjust with inflation. - Recommendation: Further reforms to market regulation, social safety nets, and anticorruption institutions are needed. Coverage of the child grant program should continue to improve, including by extending it to all districts in Nepal. ### Program modalities, financing, and numerical projections - Conditionality changes: - The primary deficit target, currently an IT, will become a quantitative PC at the January 14, 2024 test date. - The cap on the upward adjustment of the foreign-financed project loan adjustor on the primary deficit will be removed. - The revenue adjustor to the primary deficit is proposed to be removed from the July 15, 2024 test date onwards. - An IT floor on tax revenue is proposed to begin at the 5th review. - Capacity to repay: - IMF credit outstanding is projected to peak at 262.3 percent of quota in FY2024/25 (SDR 411.6 million), within the cumulative normal access limit. - This amount corresponds to 17.3 percent of exports and 1.2 percent of GDP. - The program is fully financed with firm commitments in place for the next 12 months and good prospects thereafter. Authorities intend to use the ECF arrangement for budget support. - Recent shortfalls in development partner disbursements lowered budget support financing in FY2022/23; pledges for FY2023/24 through FY2024/25 are broadly in line with the level recorded during the first and second review. ### Key fiscal and external numbers (table highlights, in percent of GDP) - FY2023/24 / FY2024/25: - External financing requirement: 0.4 / 2.7 - Total revenue and grants: 19.8 / 20.8 - Expenditure: 25.1 / 25.4 - Current account deficit 1/: 2.5 / 4.8 - Fiscal deficit: 5.3 / 4.6 - Total financing: 4.4 / 4.2 - Foreign borrowing: 1.4 / 1.4 - Current and capital grants: 1.4 / 1.4 - FDI, net: 0.4 / 0.6 - Change in reserves (+ decrease): -3.8 / -1.1 - External financing gap: 0.9 / 0.5 - Fiscal financing gap: 0.9 / 0.5 - Financing commitments so far (by source, percent of GDP): - IMF: ECF: 0.2 / 0.2 - Asian Development Bank: 0.3 / 0.1 - World Bank: 0.4 / 0.2 - Note: Current baseline forecast is as of September 28, 2023. - Footnote: 1/ Current account excludes official transfers. ### Risks, liquidity, and contingency considerations - Program risks: - Political instability could threaten policy continuity and program implementation. - A large commodity price shock could necessitate monetary tightening if not short-lived. - Shortfalls in external concessional financing would require further reduction of low priority expenditures. - Significant reduction in remittances could reduce growth, reserves, and revenues. - Elevated bank stress due to rising NPLs could raise solvency problems; NRB stands ready to provide liquidity support to prevent systemic concerns. - A large decline in remittances and/or a large natural disaster would require greater external support from development partners. - NRB actions: - Maintaining tight regulatory measures and developing liquidity facilities. - Planned loan portfolio review to improve visibility on asset quality and test the Supervisory Information System. - Scheduled financial sector reforms to implement international standards on capital and liquidity requirements. - Contingency: Government intervention in bank stress scenarios may have significant fiscal implications; interventions should be designed so that investors bear costs appropriately. ### Capacity development and staff appraisal - Capacity development (CD) remains aligned with program objectives: - Recent CD prioritized establishment of a fiscal risk register and implementation of a cash flow forecast framework. - Prospective CD: formulation of a domestic revenue mobilization strategy, preparation of a tax expenditure report, and improvements in tax administration. - Staff appraisal summary: - Growth is projected to recover to 3.5 percent in FY2023/24, below potential. - Balance sheet repair after a post-pandemic boom-bust cycle is impeding growth. - Program performance: all but one quantitative metrics met; PC on net international reserves and IT on the primary fiscal deficit were met; IT on child allowance spending missed by a slim margin. - Five of seven SBs completed (four met), representing good progress. - Policy recommendations emphasized: - Continue addressing fiscal pressures to ensure medium-term fiscal sustainability while enhancing capital spending and protecting the most vulnerable. - Maintain current cautious, data-driven monetary policy to preserve price and external stability; refine toolkit to address surplus liquidity and ensure clear authority to use tools. - Implement the 2021 Safeguards Assessment recommendations, including audits assisted by experts with international experience and amendments to the NRB Act to safeguard operational and financial independence. - Implement APG-identified AML/CFT reforms, starting with enactment of AML/CFT legislation, to avoid severe impacts on correspondent banking relationships and access to global financial networks. - Continue reforms to improve the business climate, governance, anticorruption institutions, and human capital to foster investment and inclusive growth. *Sources: Nepali authorities; and IMF staff estimates.* ### 35. Staff supports the completion of the third review of the ECF-supported program and ### 35. Staff supports the completion of the third review of the ECF-supported program and the disbursement of fourth tranche ### Program decision and financing - Staff supports the completion of the third review of the ECF-supported program and the disbursement of fourth tranche in the amount of SDR 39.2 million. - Table of phasing under the Extended Credit Facility (Table 7) shows the Third Review: November 1, 2023 — Observance of performance criteria on Jul 16, 2023, completion of third review — 39.20 SDR Million, 25% of quota. - Nepal's quota is SDR 156.9 million. ### Recent macroeconomic developments (summary of findings) - Growth and demand: - The slow-down in FY2022/23 was driven by lower fixed capital formation and domestic demand. - Real GDP (Table 1): 2021/22 Est. -2.4; 2022/23 4.8; 2023/24 5.6; 2024/25 0.8; 2025/26 3.5; 2026/27 5.2; 2027/28 5.2 (annual percent change). - Inflation: - Headline CPI (period average) (Table 1): 2021/22 6.1; 2022/23 3.6; 2023/24 6.3; 2024/25 7.8; 2025/26 7.3; 2026/27 6.2; 2027/28 5.5. - Non-food inflation has been declining steadily, but food inflation has made the decline in overall inflation less consistent. - External sector: - The current account deficit has disappeared in FY2022/23, driven by lower imports, while remittances remain buoyant. - The REER has appreciated 6.4 percent in 2023 through September, largely on Renminbi weakness and elevated inflation in Nepal. - Workers' remittances (Table 1, in millions of U.S. dollars): 2021/22 7,533; 2022/23 8,150; 2023/24 8,326; 2024/25 9,330; 2025/26 9,967; 2026/27 10,356; 2027/28 10,811. - Exports and imports: FY2022/23 current account deficit shrunk on a large drop in imports and strong remittances; exports have rebounded since 2020 but remain well below the 1990-2009 levels. - Monetary and financial sector: - Net foreign asset accumulation has driven growth in broad money as private sector credit remains subdued. - Deposit growth continued to rise at 13.2 percent as remittance growth averaged 12.9 percent since May 2022. - Private sector credit growth has fallen to single digits from a recent peak of 32.5 percent (y-o-y) in Sept 2021. - Private sector credit-to-GDP ratio remains among the highest in its peer group. - Interbank rate has hit the middle of the interest rate corridor in 2023 when liquidity was in deficit; excess liquidity was low through August 2023, so banks stopped borrowing from the Standing Liquidity Facility. ### Fiscal developments and projections (key figures) - FY2022/23 fiscal outcomes and projections: - The FY2022/23 fiscal deficit has widened to 5.9 percent of GDP driven by a sizable drop in revenue collection. - Total public debt increased to 46.7 percent of GDP in FY2022/23 (Table 1 shows Public debt percent of GDP: 2022/23 43.3; 2023/24 43.3; 2024/25 47.0; 2025/26 48.4; 2026/27 49.3; 2027/28 50.0; projections beyond reported years continue upward). - Total revenue and grants (Table 1, in percent of GDP): 2022/23 23.3; 2023/24 23.1; 2024/25 19.3; 2025/26 19.8; 2026/27 20.8; 2027/28 21.5. - Net lending/borrowing (central government, percent of GDP) (Table 1): 2021/22 -5.4; 2022/23 -4.0; 2023/24 -3.2; 2024/25 -5.8; 2025/26 -5.3; 2026/27 -4.6; 2027/28 -4.0; 2028/29 -3.6; 2029/30 -3.1 (as reported across projection horizon). - Tax revenue decline in FY2022/23 was mostly driven by a sharp drop in import-related tax revenues with large declines in VAT, customs, and excise duty. - Selected fiscal projections and budget aggregates (from Table 2a / 2b): - Tax revenue (in billions of Nepalese Rupees, Table 2a): 2022/23 700; 2023/24 870; 2024/25 984; 2025/26 1,295 (Current Baseline Proj.); 2026/27 866; 2027/28 1,305. - Total revenue (in billions of Nepalese Rupees, Table 2a): 2022/23 841; 2023/24 976; 2024/25 1,114; 2025/26 1,403. - Expenditure (in billions of Nepalese Rupees, Table 2a): 2022/23 1,074; 2023/24 1,186; 2024/25 1,297; 2025/26 1,727. ### Balance of payments and reserves (highlights) - Table 3 key items (in millions of U.S. dollars): - Current Account (levels): 2021/22 -339; 2022/23 -2,844; 2023/24 -5,174; 2024/25 -586; 2025/26 -721; 2026/27 -2,015. - Trade balance (levels): 2021/22 -9,186; 2022/23 -11,510; 2023/24 -13,759; 2024/25 -10,728; 2025/26 -11,813. - Gross official reserves (Table 3, millions of U.S. dollars): 2021/22 10,559; 2022/23 10,884; 2023/24 8,953; 2024/25 10,916; 2025/26 12,674. - Gross official reserves in months of prospective imports (Table 3): 2021/22 9.0; 2022/23 7.5; 2023/24 7.6; 2024/25 8.3; 2025/26 8.4. ### External financing and financing gap (Table 5) - Gross External Financing Requirements (in millions of U.S. dollars): 2023/24 173; 2024/25 138; 2025/26 01229 (table shows columns headed 2023/24, 2024/25, 2025/26 with breakdowns). - Financing Gap and exceptional financing (Table 5): - Financing Gap (in millions of U.S. dollars): 2023/24 419; 2024/25 234; 2025/26 292. - Exceptional/Additional Financing equals the Financing Gap: 2023/24 419; 2024/25 234; 2025/26 292. - IMF: ECF arrangement financing (Table 5): 94.1; 83.7; 41.8 (matching the period breakdown). ### Structural benchmarks, institutional reforms, and program conditionality (Table 10 and Table 8 highlights) - Structural benchmarks and status (selected): - The FCGO reports the consolidated financial information of all operational funds in annual financial statements, starting with FY2021/22 — Original target End-August 2023 — Not met — Reset to end-January 2025. - MOF submits to Parliament amendments to modernize the NRB Act, addressing key recommendations of the 2021 Safeguards Assessments Report — Original target End-August 2023 — Not met — Reset to end-April 2024. - MOF implements a fiscal risk register to capture various dimensions of major fiscal risks — End-August 2023 — Met. - NRB issues the updated regulation on asset classification — End-August 2023 — Met. - The FY2023/24 external audit of the NRB is to be conducted by the Auditor General’s Office with the service of experts with international experience in auditing and central bank auditing — New — End-July 2024. - Quantitative performance criteria and indicative targets (Table 8, selected items and status): - Stock of NRB's net international reserves (floor; in U.S. dollars million): program targets and outturns reported (e.g., Program target 8,640; Adjusted target 8,344; Outturn 8,821 — met). - Accumulation of external payments arrears (ceiling): 0 — met at test dates reported. - Indicative target: federal government spending on child allowance (floor; in NPR million): initial floors and met/not met status reported across testing dates (e.g., 5,300 program target — outturn 6,987 — met; subsequent test date outturn 6,763 — not met). ### Socio-economic and climate notes - Socio-economic indicators: - Nepal is among the lowest income countries in South Asia; poverty has fallen significantly in the last decade; remittances are one of Nepal’s most important safety nets. - Climate and environment: - Average temperatures have risen in Nepal; the country faces significant and growing climate-related shocks including landslides, floods, and storms. - Total greenhouse gas emissions are growing but represent a small percentage of global emissions. - Hydropower accounts for 90 percent of current electricity production and is set to become a major export. - Pollution is significant: Nepal is the 13th most polluted country; Kathmandu is the 16th most polluted capital city. *Source: IMF staff report material (excerpt): 35. Staff supports the completion of the third review of the ECF-supported program and the disbursement of fourth tranche in the amount of SDR 39.2 million; accompanying macro-fiscal, monetary, external, structural benchmark, and program tables and figures as provided in the source content.* ### Annex I. The Drivers and Dynamics of Growth in Nepal ### Annex I. The Drivers and Dynamics of Growth in Nepal ### Overview and objective - Nepal’s growth has been historically highly volatile and characterized by periods of large economic shocks, making forecasting challenging. - The annex identifies variables historically correlated with quarterly real GDP growth to inform nowcasts and short-term projections. - Data: 46 quarters of real GDP growth at basic prices over the period Q1 2011-Q2 2023 from the Nepal National Statistics Office (NSO), supplemented with quarterly high-frequency domestic and external variables from the IMF and the NRB. ### Empirical approach and model specification - Estimation method: Ordinary least squares (OLS) on quarterly real GDP growth (yt) with: - A vector of proxies for investment (It) including domestic credit and remittances; - A vector of proxies for input costs (Ct) including world food and oil prices; - A vector of proxies for the external sector (Xt) including imports, exports, and Indian GDP growth; - One- and four-period lags of GDP growth to capture momentum and base effects. - Steps to address empirical challenges: - General-to-specific modelling to reduce overfitting given limited sample size. - Four specifications to address the impact of large shocks (2015 earthquake and 2020 pandemic): (1) full sample, (2) dropping shock periods, (3) one dummy for each shock, (4) separate dummies for negative-growth and positive-growth shock periods. - Endogeneity acknowledged (e.g., India–Nepal growth correlation may reflect common shocks), but correlations remain useful for nowcasting; robustness includes controls for growth in China and the USA. ### Parsimonious model and main correlates (preferred specification) - Model selection: A parsimonious model (Table 2) reduces variables while retaining explanatory power; column 4 indicates the model explains 81 percent of the variation in the data (푅푅2 = 81 percent) despite having three fewer variables than the full model. Akaike and Bayesian Information Criteria (AIC and BIC) are substantially smaller for the parsimonious model, favoring parsimony. - Preferred specification: model 4 (uses full data and the richest set of shock dummies) based on relatively low AIC and BIC. - Most significant correlates in the preferred model: - India’s GDP growth, - Domestic credit growth, - Import growth. - Magnitudes in the preferred model: - 1pp higher growth in India correlates with 0.4pp higher growth in Nepal. - 1pp higher domestic credit growth correlates with 0.08pp higher growth in Nepal. - 1pp higher import growth correlates with 0.07pp higher growth in Nepal. - Four-quarter lagged GDP is a strong negative impulse on growth, consistent with base effects and Nepal’s boom-bust cycles. ### Model fit and projections - Model fit: The model fits observed quarterly GDP growth well, particularly during periods without extreme shocks. - Nowcast/projection outcomes (model output): - GDP growth in basic prices FY2022/23 is expected to be in the region of 1 percent. - GDP growth in FY2023/24 is expected to range from 5.8-6.0 percent. - The model expects growth to remain sluggish in FY2022/23 at 0.8 percent before a strong rebound in FY2023/24 above 3 percent. - Drivers of the projected trajectory: - FY2022/23 low growth reflects a high base from the previous year and poor external sector performance. - FY2023/24 pick-up is driven by low base effects, India’s strong growth, a pickup in credit, and stronger external sector performance. ### Limitations and downside risks to the projection - Statistical limitations: - Few variables are statistically significant due to small sample size and limited statistical power. - Potential instability in relationships during large shock periods; alternative specifications were used to test robustness. - Reasons growth may undershoot the model forecast: - India’s growth has historically been a good predictor of Nepal’s growth, but this relationship did not hold in 2023 and may not hold in 2024. - Historical strong rebound effects reflect boom-bust cycles driven by rapid credit expansions followed by slowdowns; current more prudent monetary and fiscal policies reduce the likelihood of a rapid rebound. - Credit growth and imports may not bounce back as rapidly as forecast; recent and proposed bank regulatory measures and banks’ concerns about rising non-performing loans may keep financial conditions tight. *Source: Annex I. The Drivers and Dynamics of Growth in Nepal (PDF).* ### 5. Nepal is highly vulnerable to climate shocks and climate change. A recent IMF working ### 1nplea2023004 - 5. Nepal is highly vulnerable to climate shocks and climate change. A recent IMF working ### Climate vulnerability and impacts - Floods, landslides, droughts, and storms combined generated GDP losses of 2.3 percent (annual basis) according to a recent IMF working paper. - Welfare losses for the average household from these shocks were 3.3 percent (annual basis). - These shocks increased the rate of undernourishment by 2.8 percent (annual basis). - A severe climate change scenario could cause GDP to be 7 percent lower by 2050 (World Bank, 2022). - Shocks have persistent negative effects on poverty and food security and disproportionately harm vulnerable households, including those not able to access finance, living in remote areas, and unable to migrate (Selected Issues Paper: Climate Change, Food Insecurity and Remittances in Nepal, 2023). - Nepal has committed to Net Zero by 2045; current greenhouse gas emissions are described as low by global standards and energy is primarily produced through hydropower. ### National Adaptation Plan (NAP) and financing - The 16th Plan concept note prioritizes policies to prevent natural disasters, enhance financial and economic stability in response to shocks, and lower emissions; it builds on the National Adaptation Plan (NAP, 2021). - NAP costed priority climate adaptation programs focus on: - (i) agriculture and food security, - (ii) industry, transport, and physical infrastructure, - (iii) disaster risk reduction and management. - Implementing the NAP in full is estimated to cost USD 47.4 billion until 2050. - Nepal has limited fiscal resources to finance these policies; a strong reform agenda could be combined with concessional climate finance (including from the RST) based on: - (i) the Climate-PIMA (2021) recommendations on incorporating climate risk in investment planning, - (ii) the World Bank Climate Change Development Report (2022) comprehensive action plan of mitigation and adaptation reforms, - (iii) the 2023 Article IV Staff Report and Selected Issues Paper focus on climate adaptation including piloting a new IMF model on climate change and food security. ### Productivity, employment, and constraints to private investment - Structural impediments hampering creation of productive jobs: - high cost of land, - capital controls, - corruption, - constraints to repatriating profits, - lack of insolvency and bankruptcy laws, - poor logistics and high transportation costs. - The concept note identifies key policies to enhance production: - improved infrastructure, - addressing knowledge and skills gaps, - ensuring timely, quality and cost-effective supply systems. - Targeted programs proposed for empowerment of disadvantaged communities. ### Recommendations from the 2023 Article IV Staff Report - Policies recommended to boost production and generate employment: - full implementation and enforcement of the Competition Act, - public investment, - creating a conducive environment for private investment, - strengthening the regulatory framework. - Measures to improve foreign investment: - removal of burdensome regulatory approval procedures, - removal of restrictions on foreign investment in sectors including agriculture, tourism and consultancy services. - Measures to mobilize domestic investment from remittances: - developing financial instruments tailored to migrant workers, - better access to finance, - efforts to improve digital and financial literacy. ### IMF-supported program context and macroeconomic outlook (from MEFP / Letter of Intent) - Commitments and recent macro outcomes: - NPLs increased from 1.7 percent in August 2022 to 3.0 percent in August 2023. - Inflation fell to 7.5 percent in August from a peak of 8.6 percent in September (year not restated in excerpt). - Reserves stood at 8.3 months of prospective imports as of July 2023. - FY2022/23 growth: - Real GDP growth slowed and could be in the range of 1-2 percent in FY2022/23 once estimates are finalized. - Current account deficit fell from 12.7 percent of GDP in FY2021/22 to 1.4 percent of GDP in FY2022/23. - FY2023/24 outlook and targets: - Inflation target: towards the FY2024 target of 6.5 percent by the end of the fiscal year. - Current account deficit expected to widen to about 1.6 percent of GDP in FY2023/24. - Medium-term outlook supported by strategic investments including hydropower and transmission lines. - Fiscal and monetary policy stance: - FY2023/24 budget envisages moderate spending growth and sanguine revenue projections to achieve strong fiscal consolidation while protecting growth through capital spending. - Budget measures include curtailing spending duplication with subnational governments and broadening the tax base towards non-import-related taxes (increasing withholding tax, personal income tax and streamlining VAT exemptions). - Monetary policy: cautiously accommodative and data-driven approach to maintain price and external stability while supporting growth. ### Risks and policy priorities - Key downside risks highlighted: - weak public expenditure execution for growth-enhancing capital projects, - stronger headwinds from post-credit boom balance sheet repair by banks and borrowers, - sharp growth slowdown in major trade- and remittance-partner economies, - volatile and higher global commodity prices (especially fuel and food) with pronounced impact on inflation, food security and the poor, - uncertainty around budget execution of revenue and expenditure, - insufficient progress on AML/CFT framework potentially hindering access to the global financial system and increasing financial stability risks, - further rise in NPLs raising concerns about bank capital adequacy ratios, - vulnerability to natural disasters and weather variability impacting food production, poverty reduction and growth. - Intended policy responses: - take forward-looking, data-driven responses to monetary and fiscal policy, - accelerate planned increase in capital spending including through concessional external financing, - continue reforms to strengthen supervisory and regulatory frameworks (bank asset classification, Supervisory Information System, loan portfolio review, oversight of savings and credit cooperatives), - implement AML/CFT recommendations and seek technical support from the IMF, - progress reforms in fiscal transparency (fiscal risk register, cash flow forecasting, tax expenditure reporting, public enterprise financial statements and audits) with some structural benchmarks proposed to be reset to later dates. *Source: Excerpts from IMF country documents for Nepal (MEFP, Letter of Intent, Selected Issues Paper, Article IV Staff Report, and related analytical notes as cited in the source content).* ### 6. Our fiscal position has been anchored by the program targets, despite a challenging ### 6. Our fiscal position has been anchored by the program targets, despite a challenging ### Fiscal position and consolidation - Overall fiscal deficit excluding revenue sharing with local governments expanded to 5.8 percent of GDP. - Lower revenue collection in the fiscal year ended July 16, 2023 created fiscal pressures despite containing spending within the mid-year budget review. - Tax revenues declined by double digits in FY2022/23 after two years of double-digit growth. - Import-related tax revenues, representing about 40 percent of total tax revenue, fell disproportionately due to import controls in the first half of the fiscal year and lower import demand from the slower economy. - Current spending was contained within the mid-year budget review despite higher interest payments; execution of capital projects remains low. - Negative federal government cash balance at end of FY2022/23 increased relative to the historical trend due to tight fiscal conditions. - Commitment to a gradual growth-friendly fiscal consolidation consistent with program framework to stabilize public debt. ### FY2023/24 budget and revenue measures - FY 2023/24 budget is broadly consistent with the program target to stabilize public debt at a moderate level. - Revenue collection expected to recover with economic growth and additional tax measures including: - increase in the personal income tax rate for the top income bracket; - higher tax rate on interest paid to bank depositors; - removal of several VAT exemptions; - other measures related to firms and excise duties. - Plan to increase absorption of external concessional financing, in particular project loans, to support growth while maintaining debt stability. - Continued reduction of expenditures that duplicate subnational government spending (including grants and subsidies and spending on goods and services) and prioritization of social spending, particularly child grants. ### Revenue Mobilization - Enhanced taxation transparency by disclosing tax exemption information to support policymaking. - Department of Customs will estimate the cost of tax exemptions and publish a list in a Ministry-wise Progress Details report. - Initial assessment of costs of non-customs-related tax (VAT, CIT, and PIT) exemptions published in September 2023 (end-August 2023 SB, not met, implemented with delay). - Update of the September 2023 publication by end-January 2024. - Plan to publish a comprehensive report on tax expenditures (end-April 2024 SB, proposed to be reset for end-January 2025) covering tax allowances, credits, deferrals, and reliefs. - Requested IMF technical assistance (TA) to support the reform; benchmark reset to allow more time for upcoming IMF TA missions. - Share a draft of the tax expenditure report with the IMF by end-May 2024. - Develop and approve a comprehensive domestic revenue mobilization strategy (end-April 2024 SB) covering tax policy, law, and revenue administration reforms; share a draft with the IMF by end-January 2024. - Reform proposals will draw on the TADAT diagnostic (late 2022) and TA report on simplifying tax policy. ### Expenditure reforms and public investment management - FY2023/24 budget measures to improve capital expenditure effectiveness: - (i) prioritizing strategically significant projects; - (ii) streamlining environmental impact assessment; - (iii) simplifying and expediting land acquisition by amending the Land Acquisition Act; - (iv) streamlining public procurement; - (v) unlocking more foreign aid disbursements; - (vi) enhancing accountability of departmental and project heads for project implementation; - (vii) enhancing project monitoring using the monitoring information system. - National Planning Commission, Ministry of Finance and line ministries to develop an action plan to improve efficiency of public investment spending and strengthen climate resilience using PIMA recommendations. - Share first draft of the action plan by mid-January 2024 with the IMF; share final draft by end-March 2024 with IMF; National Planning Commission to approve action plan by end-April 2024 (end-April 2024 SB). - Incorporate PIMA action plan into the 16th National Development Plan before submission to the Cabinet. ### Cash management and fiscal risk management - Developed cash flow forecasts with IMF TA to enhance short-term management, avoid negative treasury single account balances, improve debt management/budget formulation, and inform NRB liquidity forecasting. - Cash flow forecasts to be shared among FCGO, PDMO and NRB on a regular basis (end-September 2023 SB, met). - Prepared Government Cash Management Guidelines to support implementation; tool to produce new cash flow needs for the mid-year budget in January 2024. - Will enhance current cash flow management and may request IMF TA for TSA management. - Prepared and are implementing a fiscal risk registry (end-August 2023 SB, met) drawing on IMF TA from October 2022; will expand registry coverage to include subnational governments and PPPs. - Prepare and publish with FY2024/25 budget a fiscal risk section in the Fiscal Policy Statement building on the registry. - Prepare and publish with FY2025/26 budget a comprehensive fiscal risk statement in the Fiscal Policy Statement (new end-August 2025 SB) to analyze sensitivity of budget estimates and public debt projections to fiscal risks. - Intend to build an inventory of key risk indicators of all subnational entities supported by IMF TA. ### Oversight of public enterprises (PEs) and extra-budgetary funds - Strengthen financial oversight and governance of PEs and extra-budgetary operational funds to limit fiscal risks. - Require all majority- and wholly-owned PEs to publish FY2022/23 annual financial statements by end-August 2024 (end-April 2024 SB, proposed to be modified and reset to end-August 2024). - Update IMF on progress on this benchmark by mid-December 2023. - Four priority nonfinancial PEs (Nepal Electricity Authority, Nepal Oil Corporation, Nepal Airlines Corporation and Nepal Doorsanchar Company (Nepal Telecom)) will have FY2022/23 financial statements audited by August 2024 (end-April 2024 SB, proposed to be reset to end-August 2024). - Prioritize completion of audits of FY2023/24 financial statements of all other PEs by end of FY2024/25. - Inclusion of all extra-budgetary operational funds in annual financial statements was not completed; FCGO has action plan to incorporate extra-budgetary funds in NPSAS-based financial statements starting with FY2021/22 (end-August 2023 SB, missed, proposed to be reset to end-January 2025). ### Social spending and social safety nets - Social spending helped households cope with shocks (unpredictable weather, persistent poverty, high inflation). - Increased coverage of the child grant to all 25 districts with a low human development index and to all Dalit children. - Ensure spending on the child grant does not decline in FY2023/24 (Indicative Target) and work towards expanding the program as resources become available. - Continue to support food security and poverty reduction through child grants, mid-day meal program, and expanded Prime Minister’s Employment Program. - Developing the 16th National Development Plan to guide medium-term strategy; expected publication in early 2024. - Accelerate development of the National Social Registry (NSR), including national identification cards, supported by the World Bank; rolling out the Poverty Identification Program (PIR) registry. - NSR and PIR will facilitate identification of vulnerable households and improve targeting of social transfers. ### Monetary and exchange rate policy - Monetary policy has begun loosening cautiously, supported by regulatory policies. - Reserves have risen to a comfortable level and external pressures are currently at bay. - Annual Monetary Policy Review set the Policy Rate to decline by 50 basis points in July 2023. - Balance sheet repairs have contributed to slow credit growth despite monetary relaxation. - Accelerating planned increase in capital spending, including through concessional external financing, is important to boost aggregate demand. - Regulatory measures aim to improve lending standards to avoid another boom-bust credit cycle and facilitate loan portfolio cleanup while maintaining price and external stability. - Primary instrument for monetary policy: maintain interbank rate in the interest rate corridor (IRC), ideally close to the Policy Rate at center of the band, with regular monetary policy review statements. - NRB introduced Intraday and Overnight Lending Facilities (ILF and OLF) in February 2023 to lend at the Policy Rate; these maintained interbank rate close to Policy Rate during liquidity deficits. - Need facilities to anchor interbank rate under surplus liquidity conditions: shift of 60 percent of local government funds into commercial banks pushed rates well below the Bank Deposit Collection Rate at bottom of IRC. - Intend to introduce by January 2024 a Standing Deposit Facility to absorb liquidity at the Deposit Collection Rate. ### Financial sector policies and supervision - Bank-reported NPLs increased from 1.3 percent in July 2022 to 3 percent as of August 2023. - Core capital declined from 10.8 to 10.1 percent in June 2023 before improving to 10.5 percent in August 2023. - Bank capitalization meets the minimum requirement; vigilance warranted as NPLs may increase further. - Improving risk-based supervision with Fund support and taking into account recommendations in the Financial Sector Stability Report (FSSR). - Finalized the Supervisory Information System (excluding off-site module) for all banks (end-August 2023 SB, met); implemented a manual for onsite and offsite supervision. - Developing and enhancing credit risk modelling and assessment capabilities in anticipation of banks implementing IFRS9 next year. - Implemented the countercyclical capital buffer (CCyB) in July 2023 and will gradually phase it in. - Will use other macroprudential tools as needed for liquidity and loan growth oversight (NRB implements: single obligor limits between 25 to 50 percent of capital depending on the sector; credit to deposit ratio 90 percent; debt service to income ratio 50 percent; debt-to-equity ratio 4:1; loan to value ratios between 30 and 70 percent). - Implement SIS onsite module for class A banks by April 2024 (end-April 2024 SB). - Intend to gradually implement Basel III LCR and NSFR frameworks. - Implement FSSR recommendations to enhance banking system resilience. ### Financial cooperatives and data sharing - Amendments to some laws relating to AML and Business Promotion Bill will expand oversight and data collection for financial cooperatives. - Establish and operationalize a specialized regulatory authority to regulate and supervise financial cooperatives, with TA from the NRB. - Formalize data sharing arrangements with financial cooperatives under written agreement; NRB to closely supervise systemically important financial cooperatives. ### Asset classification, working capital loan guidelines, and loan restructuring - Issued regulations on asset classification (end-August 2023 SB, met) improving transparency and clarifying definitions on loan performance, restructuring, rescheduling, reclassification and provisioning. - Further refinements planned to align regulations with international standards and IFRS9 and ensure consistent application across banks, particularly regarding national priority projects and forbearance. - Issued Working Capital Loan (WCL) guidelines effective October 2022; amended guidelines in January and August 2023. - Commit to avoid conflicts between asset classification regulation and WCL guidelines; will enhance guidelines to reduce excessive use of WCLs while keeping adjustments targeted and timebound. - Encourage banks to restructure problem loans for viable borrowers with temporary liquidity shortages. ### Prudential framework, monitoring, and bank reviews - Assess impact of directed lending on bank business models and financial stability; monitor quality of directed loans and review directed lending amounts to unlock credit to bankable projects. - Monitor impact of interest rate regulations on monetary policy transmission and bank viability; gradually move to more market-based deposit/interest rate determination. - Streamline prompt corrective action framework with clear escalation processes; NRB to use early intervention measures, including suspension of dividend payments if a bank becomes undercapitalized. - By end-April 2024, launch in-depth on-site loan portfolio reviews for the largest 10 banks assisted by independent international third-party auditors (end-April 2024 SB). - Phase exercise to use end-July 2024 data incorporating loan portfolio review implementation; finalize Terms of Reference by end-December 2023. - Aim to complete the loan portfolio review by December 2024 (end-December 2024 new SB). - Develop a plan to deal with review findings by end-February 2025 (end-February 2025 new SB); any bank with capital shortfalls must submit timebound capital management plans. ### Governance and other structural reforms to boost growth - Continue implementing governance and structural reforms described in preceding sections to support fiscal sustainability, financial stability, and growth. *Source: Excerpt from IMF staff text in content unit 1nplea2023004.* ### 23. We are committed to further enhancing the autonomy and accountability framework ### 23. We are committed to further enhancing the autonomy and accountability framework of the NRB. ### Enhancing NRB autonomy and accountability - Conducted the audit of the FY2021/22 financial statements of NRB assisted by auditors with recognized international experience in auditing. - Will request the Auditor General, when conducting the audits of the NRB annual financial statements as per the prevailing laws of Nepal, to conduct the audits with the service of experts with international experience in auditing and central bank auditing (new end-July 2024 SB). - Drafted amendments to the NRB Act to implement recommendations of the 2021 Safeguards Assessment (SGA) and strengthen autonomy and governance practices; continued work to finalize the draft considering the 2021 SGA recommendations. - Amendment submission timing: reset end-August 2023 SB not met; proposed reset to end-April 2024 (submit amendments to the NRB Act to the Parliament by end-April 2024). ### Implementation of 2021 Safeguards Assessment (SGA) recommendations - Commitment to complete implementation of the following SGA recommendations by mid-January 2024: - Adopt a medium-term plan to strengthen staff capacity, particularly in internal audit, financial reporting, and foreign reserves management. - Advance the risk management function by adopting a business continuity policy. - Ensure accuracy of NRB monetary data by setting out procedures for compiling data, assigning responsibilities for independent review of the data and reconciliation to the financial statements at the test dates that fall on year-ends and having the internal audit department review this. - Continue to strengthen foreign exchange reserves management through better segregation of responsibilities, stronger accounting, and valuation criteria, drawing on recent IMF TA. - Implementation status note: "5 out of 16 recommendations have been fully implemented and the others are in progress." ### Strengthening AML/CFT framework - Urgently strengthening AML/CFT framework following APG mutual evaluation; Nepal will enter the International Co-operation Review Group observation period. - Commit to implementing reforms in the APG action plan, assisted by technical assistance from the Fund and other development partners, to avoid FATF listing. - Specific commitments include: - Make the utmost effort to achieve enactment of the bill “Amendments to Some Laws relating to AML and Business Promotion Bill”, in line with Financial Action Task Force AML/CFT international standards and the 2023 APG Mutual Evaluation Report (new end-July 2024 SB). - Change relevant regulations, improve capacity, enhance understanding of AML/CFT risks, and strengthen supervision and enforcement. - Note: "Anti-money laundering/combatting the financing of terrorism." ### Structural reforms and growth - Continue efforts to address structural barriers to growth, including: - Further exploring avenues to reduce the cost of doing business, including by simplifying regulatory provisions to foreign investment. - Investing in resilient and sustainable infrastructure and human capital. - Promoting trade across sectors. ### Risks and contingencies - Downside risks and global uncertainty remain; authorities stand ready to adjust policy as needed. - Policy responses depending on shock: - If growth fails to rebound and revenues are low: compress government expenditure while protecting critical capital and social spending, possibly matched with cautious monetary accommodation. - Another major commodity price shock: may require further monetary policy tightening to maintain external stability and keep inflation in check. - Foreign exchange reserves provided an important cushion for the 2022 commodity price shock; buffers are once again adequate. - If a shock is too large to be offset exclusively with buffers and needed policy adjustment, authorities will seek assistance from development partners; ability aided by low risk of debt distress and ECF-supported program commitments. - NRB readiness: improve tools, remain vigilant to prevent banking-system problems; in event of elevated bank stress, NRB stands ready to provide systemic liquidity support while triaging deeper solvency problems. - "Triaging refers to addressing solvency problems through (i) using banks’ resources, (ii) restructuring, or (iii) resolution/liquidation." ### Financing and program monitoring - Continue to mobilize resources from international development partners to support reform program alongside domestic resources. - Remaining financing needs estimated to be covered by assistance from the IMF, the World Bank, the Asia Development Bank, and other development partners. - IMF disbursements will be made available to the budget during the program period. - Program monitoring: - Monitored through quantitative performance criteria, indicative targets, and structural benchmarks as listed in Tables 1 and 2. - Technical Memorandum of Understanding (TMU) describes definitions and data provision requirements. - ECF program monitored on a semi-annual basis by the IMF Executive Board. - Request that an amount of SDR 39.20 million is made available for the third review. - Fourth and fifth reviews scheduled on or after May 1, 2024, and November 1, 2024; based on January 14, 2024 and July 15, 2024 test dates respectively. ### Structural benchmarks and selected Table 1 highlights (July 2023–January 2025) - Cross-cutting institutional reforms: - FCGO reports consolidated financial information of all operational funds in annual financial statements, starting with FY2021/22: Original End-August 2023 Not met; Reset to end-January 2025. - MOF submits to Parliament amendments to modernize the NRB Act, addressing key recommendations of the 2021 SGA: Original End-August 2023 Not met; Reset to end-April 2024. - FY2023/24 external audit of the NRB conducted by the Auditor General’s Office with service of experts with international experience in auditing and central bank auditing: New End-July 2024. - Report that "Amendments to Some Laws Relating to AML and Business Promotion bill" has been enacted in line with FATF AML/CFT international standards: New End-July 2024. - Revenue mobilization: - MOF publishes a report on tax exemptions for all other non-customs related taxes: End-August 2023 Not met, Implemented September 2023. - MOF approval of a domestic revenue mobilization strategy: End-April 2024. - MOF publishes a comprehensive report on tax expenditures: End-April 2024 Reset End-January 2025. - Fiscal sustainability and fiscal risk management: - MOF implements a fiscal risk register: End-August 2023 Met. - A comprehensive fiscal risk statement published with the FY 25/26 Budget: New End-August 2025. - MOF develops cash flow forecasting to be shared with PDMO and NRB on a regular basis: End-September 2023 Met. - All majority- and wholly-owned PEs publish their FY2022/23 annual financial statements: End-April 2024 Modified and reset End-August 2024. - Four priority nonfinancial PEs to have FY2022/23 financial statements audited: End-April 2024 Reset End-August 2024. - Financial sector regulation & supervision highlights: - NRB issues updated regulation on asset classification: End-August 2023 Met. - NRB completes full implementation of the SIS among class A, B and C banks, excluding the onsite module: End-August 2023 Met. - NRB completes implementation of the onsite module of the SIS among class A banks: End-April 2024. - Launch for 10 largest Banks in-depth on-site inspections assisted by independent international third-party auditors: End-April 2024. - NRB completes in-depth on-site inspections for the 10 largest Banks, assisted by independent international third-party auditors: New End-December 2024. - NRB finalizes a roadmap outlining its approach to the outcome of the in-depth on-site inspections: New End-February 2025. ### Selected Table 2 and program indicators highlights - Net international reserves (NIR) floor and outcomes (U.S. dollars million): - For 14-Jan-24 test date: Program target 8,640; Adjusted target 8,344; Outturn 8,821; Status: met. - For 15-Jul-24 test date: Program target 8,038; Adjusted target 6,998; Outturn 10,473; Status: met. - Program target later columns: 9,076; 9,076. - Primary deficit of the federal government (ceiling; in NPR million) examples (as shown in Table 2): - Program target and adjusted/outturn cells include values such as 435,959 and 315,628 (presented in table format). - Indicative target: federal government spending on child allowance (floor; in NPR million): values shown include 5,300; 6,987; 6,763; 3,092. - Memorandum items: - Budget support from development partners (in U.S. dollars million): sequence includes 64, 1345, 330, 171, 162, 325 (as shown in the table). - Revenues of the budgetary central government under the program (in NPR million) examples: 926,767; 938,280; 968,166; 838,029; 341,044. - Revenue targets of the budgetary central government (in NPR million) include 1,050,821; 1,066,000; 563,983; 1,248,620. - Notes from Table 2: - NIR floor target is set as a mid-point between the baseline projection and the adequacy level; any downward adjustment to the NIR floor will be capped at USD 710 million for the next 12 months to maintain reserve adequacy. - The Budget target remains NPR 1,248.620 million. - For the January 14 2024 and July 15 2024 testing dates figures are cumulative of the period from July 17, 2023 to January 14 2023 and July 17 2023 to July 15, 2024 respectively. ### Technical Memorandum of Understanding (TMU) — exchange rates, valuation, and NIR definition - Program exchange rates and valuation: - All assets and liabilities denominated in U.S. dollars (USD) converted into Nepali Rupees (NPR) at a program exchange rate of NPR 131.3 per one USD (exchange rate on July 17, 2023). - Gold holdings valued at USD 1950.3 per troy ounce (price in July 2023 from the IMF website on primary commodity prices). - Assets and liabilities denominated in SDRs and in foreign currencies not in USD converted into USD at the July 17, 2023 exchange rates reported in Table 1. - Table 1: Program Exchange Rates (selected entries preserved exactly as shown) - U.S. dollars / Nepali rupee 0.008 - U.S. dollars / U.K. pound 1.308 - U.S. dollars / Indian rupee 0.012 - U.S. dollars / Chinese yuan 0.139 - U.S. dollars / Euro 1.123 - U.S. dollars / Japanese yen 0.007 - U.S. dollars / Brunei dollar 0.756 - U.S. dollars / Korean won 0.001 - U.S. dollars / Kuwaiti dinar 3.262 - U.S. dollars / Malaysian ringgit 0.220 - U.S. dollars / Australian dollar 0.681 - U.S. dollars / Bahrain dinar 2.653 - U.S. dollars / Canadian dollar 0.759 - U.S. dollars / Danish krone 0.151 - U.S. dollars / Hong Kong dollar 0.128 - U.S. dollars / Swedish krona 0.097 - U.S. dollars / Swiss franc 1.162 - U.S. dollars / Omani rial 2.598 - U.S. dollars / Qatari riyal 0.275 - U.S. dollars / Russian ruble 0.011 - U.S. dollars / Saudi Arabian riyal 0.267 - U.S. dollars / Thai baht 0.029 - U.S. dollars / U.A.E. dirham 0.272 - U.S. dollars / Singapore dollar 0.756 - U.S. dollars / SDR 1.354 - Reference date for Nepali rupee is July 17, 2023. - Definition of Net International Reserves (NIR): - NIR = reserve assets minus reserve related liabilities of Nepal Rastra Bank (NRB) expressed in U.S. dollars. - Reserve assets (BPM6 definition) include NRB holdings of monetary gold, SDRs, Nepal’s reserve position in the IMF, foreign currency cash (including foreign exchange banknotes in the vaults of NRB), and readily available deposits abroad (including balances on accounts maintained with overseas correspondent banks). - Excluded from reserve assets: assets that are pledged, collateralized, or otherwise encumbered; claims on residents; precious metals other than monetary gold; illiquid assets; and claims on foreign exchange arising from derivatives in foreign currencies vis-à-vis domestic currency. - Reserve related liabilities include foreign exchange liabilities of the NRB to nonresidents; Nepal’s outstanding credit to the IMF; foreign currency reserves and deposits of commercial banks and other financial institutions held at the NRB; commitments to sell foreign exchange arising from derivatives; and all arrears on principal or interest payments to commercial banks, suppliers, or official export credit agencies. - For program NIR measurement, all foreign-currency related assets and liabilities will be converted into USD at the exchange rates specified in paragraph 1, Table 1. *Source: Nepal — IMF country documentation (excerpt).* ### 5. Targets for the program NIR are set as a floor. ### 5. Targets for the program NIR are set as a floor. ### Net International Reserves (NIR) targets and adjustors - NIR program targets are set as a floor. - Adjustors included in NIR targets: - Budget support from development partners: - If actual disbursements are below program projections, the NIR floor will be adjusted downward by the difference between actual and projected disbursements. - Projections of budget support for the next 12 months (Table 2): - January 14, 2024: 162 (USD million) - July 15, 2024: 365 (USD million) - Revenue collection: - If revenue collection is below program projections, the NIR target will be adjusted by the equivalent USD amount of the revenue adjustor to the primary deficit ceiling (see paragraph 10). - Cap on downward adjustment: - Any downward adjustment to the NIR floor for the two adjustors above will be capped at USD 710 million. - Note: the NIR adjustor cap is the minimum of: (i) the revenue cap converted to USD at program exchange rates; and (ii) the difference between the NIR floor and NIR adequacy levels. ### Primary deficit of the budgetary central government — definitions and coverage - Institutional coverage: - The budgetary central government consists of all entities listed in the Administrative Expenditure Estimate table of the budget (Table 3). - Primary deficit definition: - Primary deficit = primary expenditures minus revenues. - Primary expenditures: - Include capital expenditures and recurrent expenditures except interest payments. - Exclude financing expenditures (amortization of domestic and external borrowing, loan and share investment in public enterprises and other enterprises, foreign share investments). - Recurrent expenditures (excluding interest) include compensation of employees, use of goods and services, subsidies, grants, social security, other current expenditure. - Revenue sharing for province and local levels is excluded. - Revenues: - Revenues to be deposited in the Federal Treasury (all taxes and non-tax revenue as defined in the budget). - Revenue sharing for province and local levels excluded. Other receipts excluded. - Recognition basis: - Revenues and primary expenditures should be recognized on a cash basis. - Monitoring source: - Financial Comptroller General Office monthly reports will be used as the basis for program monitoring. - Target characteristics: - Targets for the primary deficit are set as a ceiling. - Targets are set for cumulative flows from the end of the previous fiscal year. ### Primary deficit adjustors (phased out starting July 15, 2024) - Adjustor for revenue shortfalls: - If revenue outturn is below the program projection, the primary deficit ceiling will be adjusted upward by the difference. - Upward adjustment capped at NPR 61,009 million for January 15, 2024. - Adjustor for revenue windfalls: - If revenue outturn is above the program projection but below MOF revenue collection targets: no adjustment to the primary deficit target. - If revenue outturn exceeds MOF revenue collection targets: primary deficit ceiling will be adjusted downward by the difference. - Purpose: permit higher spending with modest overperformance while promoting buildup of fiscal buffers for large overperformance. - Program revenue projections and MOF targets (Table 4): - Date: January 14, 2024 - Revenues Projected under the Program, Cumulative over the Respective Fiscal Year (NPR million): 341,044 - MOF Revenue Collection Targets, Cumulative over the Respective Fiscal Year (NPR million): 563,983 ### Adjustors for foreign‑financed project loan disbursements (concessional terms) - Higher-than-projected disbursements: - Primary deficit ceiling adjusted upward by the difference between actual and projected disbursements. - Upward adjustment cap for the indicative target for the 3rd review equals the difference between the budget amount and the projected level of disbursement for the indicative target for the 3rd review. - Cap does not apply for the quantitative performance criteria for the 4th and all subsequent reviews. - Rationale: program does not constrain foreign-financed project loan disbursements on concessional terms. - Lower-than-projected disbursements: - Primary deficit ceiling adjusted downward by the difference between actual and projected disbursements. - Aligns project spending with actual disbursement. - Disbursement projections (Table 5): - January 14, 2024: 13,977 (Million NPR), cumulative over the respective fiscal year - July 15, 2024: 83,832 (Million NPR), cumulative over the respective fiscal year ### Indicative targets on social spending and tax revenues - Social spending (indicative target): - Focus on child grant spending (activity codes 7.1.1.10, 7.1.1.41, 7.1.1.43). - Child grant indicative targets set as a floor for cumulative flows from the end of the previous fiscal year. - Spending recognized on a cash basis when cash is paid. - Rationale: child grant reaches vulnerable households, implemented by the federal government, monitorable timely; health and education are being devolved and not fully under federal control. - Indicative target on tax revenues (starting July 15, 2024 test date): - Defined as tax revenue of the federal government (tax revenues of the budgetary central government deposited in the Federal Treasury). - Non-tax revenue and revenue sharing for provinces/local levels excluded; other receipts excluded. - Import-related tax revenue includes import-related customs, VAT, and excise duty. - Monthly MoF data will be used for program monitoring. - Indicative tax revenue targets are set as a floor for cumulative flows from the end of the previous fiscal year. ### Continuous performance criteria - A continuous quantitative performance criterion: prohibition on accumulation of new external payments arrears on external debt contracted or guaranteed by the budgetary central government or NRB. - External payment arrears definition includes total amount of external debt service obligations (principal and interest), penalties, and interest charges not paid at maturity, excluding: (i) arrears subject to debt rescheduling agreements or negotiations; and (ii) disputed external debt service obligations. - Debt definition (per paragraph 8 of the Guidelines on Public Debt Conditionality): - Debt means current, not contingent, liability under a contractual arrangement requiring payments in assets or services per a specified schedule; includes loans, suppliers’ credits, leases (present value at lease inception), repurchase agreements, official swap arrangements, and arrears/penalties/judicially awarded damages arising from contractual payment failures. - Standard continuous PCs include prohibitions on: 1. Imposition or intensification of restrictions on payments and transfers for current international transactions. 2. Introduction or modification of multiple currency practices. 3. Conclusion of bilateral payments agreements inconsistent with Article VIII. 4. Imposition or intensification of import restrictions for balance of payments reasons. ### Provision of information to the IMF — monitoring and reporting - Authorities to transmit promptly any data revisions within 14 days after being made; any data indicating non-observance of continuous PCs to be provided immediately. - Reports and data to be transmitted electronically and in English. - Authorities to inform IMF staff immediately of creation of any new extra-budgetary funds or programs with fiscal operations. - Selected data reporting requirements and submission lags (Table 6 highlights): - Ministry of Finance: - Summary of budgetary central government accounts (cash basis): Monthly, 30 calendar days. - Summary of net incurrence of liabilities and foreign-financed project loan disbursements: Quarterly, 30 calendar days. - Domestic and external public debt stock (annual): Annually, 60 calendar days. - Social spending data and child grant program data: Half-yearly, 30 calendar days. - Public Debt Management Office: - Stock of outstanding external debt payment arrears by creditor: Quarterly, 30 calendar days. - Nepal Rastra Bank (NRB): - Exchange rate data: - (i) Monthly official exchange rates NPR/$ (data to be submitted once a week for the previous week): Monthly, 5 working days after the end of the month. - (ii) Monthly average buy and sell exchange rates NPR/$ as quoted by foreign exchange bureaus and banks: Monthly, 5 working days after the end of the month. - Monthly consumer price indexes (CPIs): Monthly, 30 calendar days. - Program net international reserves and components at program and current exchange rates: Monthly, 7 working days. - Breakdown of gross foreign assets and liabilities by currency at actual and program exchange rates: Monthly, 15 calendar days. - Balance of payments (BPM6): Monthly, 30 calendar days. - Central bank daily purchases and sales of foreign exchange by counterparts: Weekly, 2 working days after the end of the week. - Daily interbank turnover in the FX spot market: Weekly, 15 working days. - Commercial bank-by-bank data and foreign currency loan/deposit breakdowns: Monthly, 75 calendar days. - Note: Frequency codes — A = Annually; Q = Quarterly; H = Half-yearly; M = Monthly; W = Weekly. Reports and data are provided in English and in excel files. Submission lags counted after the end of the respective week, month, quarter, or fiscal year in Nepali calendar unless otherwise indicated. *Source: 1nplea2023004 - 5. Targets for the program NIR are set as a floor.* ### Introduction ### Introduction ### Program Performance - Authorities view the Extended Credit Facility (ECF) program as a critical policy anchor for fiscal sustainability, governance and economic reforms, and macroeconomic stability. - Program implementation: - Achieved five out of the seven Structural Benchmarks (SBs); one SB was completed with delay. - Two SBs have been proposed to be reset. - Performance criterion (PC) on net international reserves was met. - All standard continuous PCs were met. - Indicative Target (IT) on the primary fiscal deficit was met. - Indicative Target (IT) on child grant spending was marginally missed and is being addressed. ### Recent Macroeconomic Developments and Outlook - Economic rebound: - Economy rebounded strongly from the COVID-19 pandemic, supported by robust macroeconomic fundamentals and timely policy responses. - External sector buoyed by remittances and tourist arrivals, with imports subdued. - Current account and reserves: - Current account deficit narrowed from 12.7 percent of GDP in 2021/22 to 1.4 percent in 2022/23. - Current account deficit is projected to remain below 5 percent in the medium term. - International reserves registered a substantial improvement in FY 2022/23 and are projected to improve further. - Growth and drivers: - Economic growth decelerated in 2022/23 due to lower credit growth, low imports, supply-chain disruptions, agricultural shocks and substantial post-pandemic emigration. - FY 2023/24 growth is projected to recover back to potential, supported by gradual recovery in domestic demand consistent with a cautiously accommodative monetary policy stance and prudent fiscal measures. - On the supply side, strong growth observed in tourism and the electricity sector due to additional hydropower capacity. - Inflation: - Headline inflation stood at 7.5 percent in mid-October 2023 compared to 8.5 percent in mid-October 2022. - Inflation is expected to moderate to the 6.5 percent target by the end of FY 2023/24, supported by cautious monetary policy, low credit growth, and lower imported inflation. ### Monetary and Exchange Rate Policy - Nepal Rastra Bank (NRB) priorities: - Committed to price and external sector stability and preserving credibility of Nepal’s exchange rate peg by keeping adequate reserves. - Recent actions and stance: - NRB cautiously eased monetary policy in July 2023 against moderating inflation and improved external sector. - Easing helped lower the weighted average interbank rate, but credit demand remains weak due to necessary balance sheet repairs. - NRB is taking measures to maintain stability of the interbank rate within the interest rate corridor; the standing deposit facility rate acts as the floor. - NRB committed to data-driven monetary policy decisions in line with program recommendations. ### Fiscal Policy - Fiscal stance and reforms: - Authorities committed to fiscal reforms to ensure fiscal sustainability and build buffers to increase resilience. - Fiscal deficit increased slightly in FY 2022/23 due to a decline in tax revenues but remained within the program’s projections. - Tax and expenditure measures introduced in 2023/24 to address near-term fiscal pressures. - Specific measures: - Tax measures include a 39 percent maximum income tax rate and removal of VAT exemptions for a number of items. - Government measures to address spending duplication with subnational governments and to improve capital spending. - Revenue mobilization and public investment: - Authorities are developing a revenue mobilization strategy and advancing an action plan to address the public investment efficiency gap in line with the Public Investment Management Assessment (2021) recommendations. ### Debt, Reserves, and Public Financial Management - Debt and reserves: - Public debt remained elevated at 47 percent of GDP at the end of FY 2022/23. - External debt stood at 21.7 percent of GDP at the end of FY 2022/23, almost the same as FY 2019/20. - Debt Sustainability Analysis (May 2023) shows Nepal is at low risk of debt distress for both external and overall debt. - Despite a large trade deficit, high remittances and concessional external financing helped maintain adequate international reserves and meet debt obligations. - Public financial management reforms: - Authorities committed to significant public financial management reforms. - Fiscal risk register maintained and to be expanded to subnational governments. - Cash flow forecasting system operationalized to improve budget forecasting. - Authorities agree on the need to audit financial statements of public enterprises and are committed to implementing related structural benchmarks. ### Financial Sector - Overall soundness: - Financial sector broadly sound and resilient; capital adequacy ratios and liquidity ratios are above regulatory minimum. - Non-performing loan (NPL) ratio has increased recently but remains below 5 percent. - Regulatory and supervisory reforms: - NRB adopting Asset Classification Guidelines and Working Capital Loan Guidelines to address vulnerabilities and support sustainable credit growth. - Implementation of the Supervisory Information System (SIS) and reintroduction of a counter-cyclical buffer. - Preparations started for a loan portfolio review of the ten largest banks to be completed within ECF time limits. - NRB plans to introduce the on-site module in SIS and the liquidity ratios under BASEL III. - Plan to establish and operationalize a specialized regulatory authority to regulate and supervise financial cooperatives. - Commitment to introduce further reforms per the Financial Sector Stability Review recommendations. ### Governance and Transparency - Priorities and measures: - Governance and transparency are key priorities. - Authorities committed to implementing feasible recommendations of the safeguards assessment to maintain NRB autonomy and strengthen transparency. - Commitment to improve the AML/CFT framework by enacting necessary legal arrangements. - Amendments to 19 laws submitted to parliament to strengthen the legal framework. - NRB has established a separate division for AML/CFT supervision of commercial banks. - Authorities welcome technical assistance to strengthen these areas and will act on new or emerging AML/CFT risks and adopt further anti-corruption measures as necessary. ### Conclusion and Requests - Authorities reiterate commitment to the ECF program objectives and request completion of the Third Review. - Assessment of ECF program: - Program has helped maintain macroeconomic stability, introduce reforms, and improve governance. - Structural reforms are aligned with domestic policy priorities. - Requests: - Authorities look forward to further IMF support in capacity development to address constraints. - Authorities thank the IMF Executive Board and management, and international partners for continued support. *Source: 1nplea2023004 - Introduction* --- _Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1nplea2023004.pdf_