## 1nplea2024001-print-pdf

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---

### EXECUTIVE SUMMARY — Context and recent developments
- Economic activity:
  - Real GDP growth: projected recovery to 3.1 percent in FY2023/24 from 2.0 percent in FY2022/23 (main text); expected rebound to 4.9 percent in FY2024/25.
- Inflation:
  - Declined from 8.2 percent in September 2023 to 4.4 percent in May 2024.
  - Expected to remain within the authorities’ target ceiling of 5.5 percent for FY2024/25 and beyond.
- External sector:
  - Current account balance projected to turn positive in FY2023/24 (already at 3.1 percent of GDP in first 9 months of the fiscal year).
  - Gross international reserves: USD13.2 billion as of March 2024 (9.1 months of prospective imports).
  - External position: assessed stronger than implied by medium-term fundamentals and desired policies.
- Financial sector and credit:
  - Credit growth subdued at 5.6 percent (y-o-y through May 2024).
  - Non-performing loans (NPLs) for commercial banks: 1.3 percent in June 2022 to 4.0 percent as of April 2024.
- Fiscal developments:
  - Tax revenue grew by 9.1 percent year-on-year by mid-May in FY2023/24.
  - Tax revenue-to-GDP ratio: pre-pandemic average 18.5 percent; 16.2 percent in FY2022/23.
  - Primary balance improvement: spending restraint in January 2024 mid-term budget review expected to yield +0.7 percent of GDP in FY2023/24.
- Capacity and vulnerabilities:
  - Hydropower generation capacity: currently 3000 MW; projected to double within next four years and triple in the medium term (based on latest PPAs data).
  - Domestic political uncertainty and natural disaster/climate shock vulnerability noted as key risks.

### OUTLOOK AND RISKS
- Growth outlook:
  - Real GDP growth: rebound to 4.9 percent in FY2024/25, driven by pickup in public investment and recovery in domestic demand.
- Inflation outlook:
  - Projected to remain within NRB’s target ceiling of 5.5 percent for FY2024/25 and beyond.
- External outlook:
  - Imports expected to revive with pent-up demand and higher execution of public and private capital expenditure (especially energy).
  - Slower remittance growth and import pickup expected to normalize reserves and align external position with fundamentals over medium term.
- Key risks:
  - Elevated political volatility and weak policy execution.
  - Failure to raise capital project execution would deprive the economy of stimulus.
  - Intensification of financial vulnerabilities: further rise in NPLs, weak capitalization, or SACCO failures.
  - Continued large emigration could reduce labor force and dampen demand.
  - External shocks: high commodity prices and trade restrictions in partner economies.

### PROGRAM PERFORMANCE AND REFORM IMPLEMENTATION
- Program status:
  - Broadly on track; all but one quantitative metric met.
  - Performance criteria (PCs) on net international reserves (floor) and primary fiscal deficit (ceiling) met; all continuous PCs met.
  - Indicative target (IT) on child spending (floor) missed due to technical difficulties transitioning to a new electronic payment system.
- Structural benchmarks (SBs):
  - Three out of five SBs completed (two met); two SBs proposed to be reset.
  - Achievements: on-site module of Supervisory Information System (SIS) for class A banks implemented; National Planning Commission approved PIMA action plan; Domestic Revenue Mobilization Strategy approved in early June.
  - Loan Portfolio Review (LPR): procurement of international advisors started; launch expected end-August 2024 (new proposed SB date).
  - Amendments to NRB Act under discussion; proposed SB reset to end-September 2024.

### POLICY RECOMMENDATIONS (selected)
- Fiscal policy:
  - Execute planned increase in capital spending in FY2024/25 while maintaining fiscal discipline via domestic revenue mobilization and rationalization of current spending.
  - Strengthen public investment management; advance fiscal transparency.
  - Support vulnerable groups: full execution of child grant budget; future expansion to all districts.
  - Staff projects increase in revenue-to-GDP ratio of about 1.0 pp of GDP in FY2024/25 (relative to 3.7 percent in the new budget).
  - Fiscal deficit projected to decline to 4.1 percent of GDP in FY2024/25 (compared to 4.6 in the 3rd review).
  - FY2024/25 tax measures: introduce green tax on petroleum products; adjust tax structures on electric and conventional vehicles; increase excise duties on alcohol, beer, and tobacco; improve tax compliance; partially offset by duty reductions and VAT exemptions on some agricultural products.
- Monetary and financial sector:
  - Maintain cautious, data-driven monetary policy to preserve price and external stability.
  - Avoid boom-bust credit cycles; maintain reforms on lending practices and asset classification; strengthen bank capitalization.
  - Swiftly implement plans to address SACCO vulnerabilities, reform supervisory framework and architecture.
- Governance and structural reforms:
  - Improve AML/CFT framework; accompany law amendments with secondary legislation and effective implementation.
  - Implement 2021 IMF Safeguards Assessment recommendations regarding NRB Act and NRB external audit.

### FURTHER STAFF APPRAISAL POINTS
- Staff supports completion of fourth review and disbursement of fifth tranche in amount of SDR 31.4 million.
- Program baseline forecast as of June 10, 2024.

---

### FISCAL CONSOLIDATION AND PUBLIC DEBT OUTLOOK
- Gradual fiscal consolidation:
  - Primary deficit: from 3.0 percent of GDP in FY2023/24 to 2.5 percent in FY2024/25 and to 1.1 percent in FY2028/29.
- Debt outlook:
  - Public and external debts assessed at low risk of debt distress (DSA).
  - Public debt on track to stabilize at 50 percent of GDP by FY2026/27 (a year earlier than 3rd review projection).
  - Share of external financing projected to remain below pre-pandemic levels.

### DOMESTIC REVENUE MOBILIZATION, PUBLIC INVESTMENT, SOCIAL SUPPORT
- DRMS:
  - Implementing Domestic Revenue Mobilization Strategy (approved June 2024) will boost tax revenue via administration enhancements and base broadening.
  - Forecasted 1.0 percentage points of GDP rise in tax revenue for FY2024/25 mainly from: rebound in imports 0.7 percentage points; new tax measures 0.2 percentage points; tax administration improvements 0.1 percentage points.
  - Fund TA-based estimates: full implementation could raise 3.7-4.1 percentage points of GDP over five years.
- PIMA action plan:
  - Revise National Project Bank Operational Procedures and Unified Directives (end-March 2025 SB).
  - Update and link NPBMIS with LMBIS; include all multi-year projects for monitoring/budgeting.
- Social protection:
  - Ensure full execution of child grant budgets and aim to extend coverage from 25 districts to all 77 districts.

### FISCAL TRANSPARENCY, PUBLIC ENTERPRISES, FISCAL RISK MANAGEMENT
- Tax expenditure and exemptions:
  - Authorities enhancing initial estimates of customs duty exemptions; plan to publish comprehensive tax expenditure report (end-January 2025 SB).
- Fiscal risk disclosures:
  - Fiscal risk section published in Fiscal Policy Statement FY2024/25; comprehensive fiscal risk statement planned with FY2025/26 budget (end-August 2025 SB).
- Public enterprises:
  - Publish FY2022/23 annual financial statements of all majority- and wholly-owned PEs by August 2024 (end-August 2024 SB).
  - Audits of three of four priority nonfinancial PEs completed; Nepal Airlines audit committed by end-August 2024.
- Treasury and EBUs:
  - New cash flow forecasting framework and IMF TA to improve TSA balances.
  - Inclusion thresholds for EBUs: federation > NPR 50 million; provincial > NPR 20 million; local > NPR 5 million.

---

### MONETARY POLICY, IRC, AND MARKET FUNCTIONING
- De facto monetary stance:
  - Effective target moved from midpoint of IRC to the bottom; reduction in December 2023 of bottom of corridor by 150 basis points.
  - De facto target rate fallen by about 400 basis points since July 2023.
  - Lending rates have come down approximately 200 basis points as of May 2024.
- Policy measures:
  - Implementing IRC framework with active intervention to keep interbank rate at the midpoint recommended.
  - Deposit Collection Facility introduced February 2024 to absorb liquidity at bottom of IRC.
  - Finance Ministry ended counting of local government bank deposits in deposit calculations in April 2024, causing ~10 percent fall in money supply.

### MONETARY AND CREDIT DEVELOPMENTS (selected figures)
- Broad money growth: 12.9 percent (y-o-y) in April 2024 (largely due to net foreign asset accumulation).
- Private sector credit growth remains in single digits; private sector credit-to-GDP ratio among highest in peer group.
- Selected annual percent change series (from Table 1):
  - Broad money: 21.8; 6.8; 11.4; 12.5; 10.4; 10.8; 11.7; 10.5; 10.6; 10.7; 10.7
  - Domestic credit: 26.8; 17.9; 8.8; 8.8; 11.3; 9.3; 11.2; 9.4; 10.1; 10.5; 10.7
  - Private sector credit: 26.3; 13.3; 4.6; 5.5; 8.6; 7.8; 8.8; 8.2; 9.5; 10.3; 10.6
- Private sector credit (percent of GDP) memorandum: 95.1; 94.2; 91.7; 89.3; 89.4; 87.2; 87.1; 85.3; 84.4; 84.1; 84.1

---

### FINANCIAL SECTOR VULNERABILITIES, SUPERVISION, AND LPR
- NPLs and provisioning:
  - Banking system aggregate coverage ratio: 70 percent.
  - Aggregate Tier-1 capital ratio of commercial banks: 10.2 in April 2023 to 9.7 percent in April 2024 (regulatory minimum 8.5 percent).
  - Two small commercial banks do not meet capital requirement by a small margin and are undertaking remedial actions.
- NRB actions:
  - Phased out forbearance on restructuring/rescheduling loans in mid-April.
  - Preparing Loan Portfolio Review (LPR) for ten largest banks: TOR agreed February 2024; procurement ongoing; launch proposed end-August 2024; conclude consultant work by end-February 2025; finalize roadmap by end-February 2025.
  - LPR to inform reforms related to bank resolution framework consistent with 2023 FSSR recommendations.
- Supervision enhancements:
  - On-site module of SIS implemented (end-April SB met).
  - Reintroduction of counter-cyclical buffer following two-year suspension.
  - Plans to introduce NFRS 9 and expected credit loss modeling in next fiscal year.
  - Finalize policy framework for Basel III LCR with view to implement in FY2024/25.

---

### SACCOs — SCALE, RISKS, AND REFORM ROADMAP
- Sector scale and recent failures:
  - Over 14,000 SACCOs holding estimated NPR 478 billion of savings deposits (1/12th the size of banking sector deposits in June 2023).
  - Recent collapses of several SACCOs in last six months caused loss/freeze of client savings and small-scale social unrest.
- Main causes of failures:
  - Investment in illiquid and underperforming assets; weak governance; fraud in some cases.
- Recommended multi-stage strategy:
  - Immediate (within 6 months): suspend registering new SACCOs (already done); address data gaps; triage problematic SACCOs; operationalize PCAMCs; use existing legal framework for resolution options (liquidation with depositor repayment; transfer assets/liabilities to healthy SACCO; restructuring).
  - Near-term (within 1 year): tighten and enforce regulatory requirements proportional to size; implement new regulatory framework including a central second-tier supervisory authority; regular reporting and enforcement powers.
  - Medium-term (1-2 years): start licensing of SACCOs; expand institutional architecture (debt information center, credit tribunal, savings and guarantee fund aligned with DCGF model).
- Authorities actions:
  - Suspended registration; FY2024/25 budget announces establishment of new supervisory regulatory agency and repayment of depositors of failed SACCOs.

---

### ANNEX I — PRIVATE SECTOR CREDIT: KEY FINDINGS
- Background:
  - Private sector credit expanded significantly in recent years; credit-to-GDP ratio reached close to 100 percent.
  - Recent correction follows decade-long rapid credit growth.
- Measuring the credit cycle:
  - Credit gap measure: deviation of credit-to-GDP from long-term trend (adjusted HP filter).
  - Historical behavior: pre-pandemic credit gap averaged ~1 pp in booms and -1 pp in deleveraging; pre-pandemic extremes: peak ~2.5 pp in FY2018/19; trough ~-4 pp after 2015 earthquake.
  - Post-pandemic cycle: credit gap expanded above 10 pp at peak and contracted to ~-5 pp recently — an outlier.
- Drivers and causality:
  - Pre-pandemic (2012Q3-2020Q3): output gap led credit gap by one quarter; Granger causality: output gap → credit gap (F-Stat 8.2957, Prob. 0.0015); credit gap → output gap not supported (F-Stat 0.0691, Prob. 0.9334).
  - Post-pandemic (2020Q4-2023Q4): credit and output gaps contemporaneous; Granger causality: credit gap → output gap (F-Stat 5.3062, Prob. 0.0341); output gap → credit gap not supported (F-Stat 0.1112, Prob. 0.8961).
  - Interpretation: pre-pandemic cycles largely demand-driven; post-pandemic cycle appears supply-driven (credit driving domestic demand).
- Investment-to-credit ratio (ICR):
  - Rising ICR historically signaled credit allocation to productive investment.
  - Post-pandemic: ICR declined despite booming credit growth in FY2020/21-FY2021/22; both private and public investment-to-GDP ratios have been declining post-pandemic.
- Sectoral credit performance (median growth rate, percentage points):
  - Total credit median growth rates:
    - Expansion (pre-pandemic): 5.75
    - Deleveraging (pre-pandemic): 2.07
    - Expansion (latest): 21.24
    - Deleveraging (latest): -5.87
  - Selected sector-group median growth rates:
    - G1. Agriculture — Expansion (latest) 3.17; Deleveraging (latest) -0.48
    - G3. Energy, Transportation, Communications, & Public Services — Expansion (latest) 1.63; Deleveraging (latest) 0.04
    - G8. Household Consumption — Expansion (latest) 6.70; Deleveraging (latest) -2.12
    - G6. Wholesale & Retail Trade — Expansion (latest) 4.07; Deleveraging (latest) -1.36
    - G4. Private Services — Expansion (latest) 1.09; Deleveraging (latest) -0.66
    - G5. Real Estate — Expansion (latest) 0.45; Deleveraging (latest) -0.21
- NPLs:
  - Class A banks' gross NPL ratio increased by about 2.7 percentage points between October 2021 and April 2024 (from 1.2 to 3.9 percent).
  - Wholesale & Retail: largest rise in NPL ratios and ~one third of all NPLs.
  - Agriculture-related: 15 percent of all NPLs; Construction: 10 percent; Consumable loans: 10 percent; Non-food production: 8 percent.
- Policy implications:
  - Pre-pandemic cycles: demand-driven, investment-oriented.
  - Post-pandemic boom: supply-driven due to broad regulatory easing, credit channeled to households and non-tradable sectors, lower ICR, higher inflation.
  - Regulatory response: tightening asset classification and lending practices, restoring bank balance sheet health, executing LPR to inform remedial actions, steer lending towards productive sectors and avoid disruptive boom-bust cycles.

---

### FINANCING, COMMITMENTS, AND PROSPECTS
- Program financing:
  - Program fully financed with firm commitments for next 12 months.
  - Budget support financing FY2022/23 lower than projected; pledges for FY2023/24–FY2024/25 above third review level.
  - Authorities intend to use ECF arrangement for budget support.
  - Current baseline forecast as of June 10, 2024.
- Projected financing gap (Text Table 2 — selected figures):
  - External financing requirement: -2.7 (FY2023/24), 1.5 (FY2024/25)
  - Current account deficit1/: -2.6 (FY2023/24), 2.2 (FY2024/25)
  - Foreign borrowing: 1.4 (FY2023/24), 1.4 (FY2024/25)
  - Current and capital grants: 0.9 (FY2023/24), 0.9 (FY2024/25)
  - FDI, net: 0.2 (FY2023/24), 0.3 (FY2024/25)
  - Change in reserves (+ decrease): -6.1 (FY2023/24), -2.1 (FY2024/25)
  - External financing gap: 0.8 (FY2023/24), 0.9 (FY2024/25)
  - Total revenue and grants: 19.3 (FY2023/24), 20.2 (FY2024/25)
  - Expenditure: 24.0 (FY2023/24), 24.4 (FY2024/25)
  - Fiscal deficit: 4.7 (FY2023/24), 4.1 (FY2024/25)
  - Total financing: 3.8 (FY2023/24), 3.3 (FY2024/25)
  - Foreign borrowing (fiscal financing need): 0.7 (FY2023/24), 0.7 (FY2024/25)
  - Domestic borrowing: 4.4 (FY2023/24), 3.8 (FY2024/25)
  - Fiscal financing gap: 0.8 (FY2023/24), 0.9 (FY2024/25)
- Financing commitments so far (FY figures):
  - IMF: ECF 0.2 (FY2023/24), 0.2 (FY2024/25)
  - Asian Development Bank: 0.3 (FY2023/24), 0.3 (FY2024/25)
  - World Bank: 0.3 (FY2023/24), 0.4 (FY2024/25)

### RISKS, SHOCK SCENARIOS, AND MITIGANTS
- Key risks:
  - Political instability; weaker reform commitment.
  - Large adverse commodity price shock.
  - Significant reduction in remittances.
  - Large natural disaster.
- Mitigants:
  - Reserve growth provides backstop.
  - Program flexibility through adjustors on fiscal targets.
  - NRB maintaining tight regulatory measures and liquidity facilities.
  - NRB plans to enable banks to raise more capital.
- Fiscal guidance in stress:
  - Spending restraint should protect public investment and social spending.
  - Any systemic event may require government intervention; ensure investors bear costs and prioritize unanticipated fiscal space to public investment.

---

### CAPACITY DEVELOPMENT (CD) AND TECHNICAL ASSISTANCE
- CD aligned with program objectives; recent priorities include DRMS development, PIMA action plan, SGA implementation, revenue administration improvements, and tax expenditure report preparation.
- Fund and SARTTAC CD underway: improve statistics (national accounts), strengthen monetary policy implementation framework, sustain cashflow forecasting reforms.
- Prospective CD: focus on SGA implementation, financial sector strengthening, and road map for FSSR recommendations; Fund TA to enhance AML/CFT framework.

---

### DEBT SUSTAINABILITY AND CAPACITY TO REPAY
- IMF credit outstanding projected to peak at 14.8 percent of exports and 1.1 percent of GDP in FY2024/25.
- Nepal’s outstanding IMF credit relative to key macro metrics remains low compared to other UCT arrangements of PRGT-eligible countries; debt service indicators fall within interquartile range of comparator group.
- Authorities’ track record of servicing IMF debt is strong.
- DSA highlights:
  - Public debt at 47 percent of GDP in FY2022/23; projected to peak at 50 percent of GDP in FY2025/26 and stabilize thereafter.
  - PV of external debt estimated at 14.5 percent of GDP in FY2022/23.
  - Debt vulnerabilities judged low risk given high remittances, concessional borrowing, and reserve buffers.
  - Composite indicator (CI) score: 3.14 (October 2023 WEO and 2022 World Bank CPIA).

---

### MONITORING FRAMEWORK, TMU, AND PERFORMANCE TARGETS
- Program monitored through quantitative PCs, indicative targets, and SBs; TMU describes definitions and data requirements.
- Review schedule:
  - Fifth review on or after November 1, 2024; test date July 15, 2024.
  - Sixth review on or after May 1, 2025; test date January 13, 2025.
  - Seventh review on or after November 1, 2025; test date July 15, 2025.
- TMU program exchange rates and valuations:
  - Program exchange rate: NPR 133.3 per USD (exchange rate on May 20, 2024).
  - Gold valued at USD 2333.6 per troy ounce (April 2024 IMF primary commodity prices).
- Selected quantitative targets (FY2023/24, NPR million / USD million):
  - Primary deficit (federal government ceiling): Program target 435,959; Adjusted target 440,278; Outturn 178,827 — Status: met (15-Jul-24).
  - Stock of NRB net international reserves (floor, USD million): Program target 8,038; Adjusted target 6,998; Outturn 10,473 — Status: met (15-Jul-24).
  - Indicative target: federal government spending on child allowance (floor, NPR million): 6,987; Outturn 6,763 — Status: not met (15-Jul-24).

---

*Source: 1nplea2024001-print-pdf — IMF staff report (current baseline forecast as of June 10, 2024).*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Context and recent developments
- Subdued economic activity has helped strengthen the external position and ease inflation.
- Real GDP growth:
  - Expected to rebound to 4.9 percent in FY2024/25.
  - Projected recovery to 3.1 percent in FY2023/24 from 2.0 percent in FY2022/23 (main text).
- Inflation:
  - Declined from a recent peak of 8.2 percent in September 2023 to 4.4 percent in May 2024.
  - Expected to remain within the authorities’ target ceiling of 5.5 percent for FY2024/25 and beyond.
- External sector:
  - Current account balance projected to turn positive in FY2023/24 (already at 3.1 percent of GDP in first 9 months of the fiscal year).
  - Gross international reserves increased to USD13.2 billion as of March 2024 (9.1 months of prospective imports).
  - External position assessed to be stronger than implied by medium-term fundamentals and desired policies.
- Financial sector and credit:
  - Credit growth subdued at 5.6 percent (year-on-year through May 2024).
  - Non-performing loans (NPLs) for commercial banks increased from 1.3 percent in June 2022 to 4.0 percent as of April 2024.
  - NPL rise reflects unwinding of forbearance, longer-term evergreening practices, weak GDP growth, regulatory tightening, and capital adequacy pressures.
- Fiscal developments:
  - Tax revenue grew by 9.1 percent year-on-year by mid-May in FY2023/24 (broadly in line with nominal GDP growth projection).
  - Tax revenue-to-GDP ratio declined from a pre-pandemic average of 18.5 percent to 16.2 percent in FY2022/23.
  - Factors in lower tax-to-GDP: weaker imports (about 0.8 percent of GDP), transition to electric vehicles with lower import duties (0.4 percent of GDP), intensified informal trade, and export restrictions in partner countries.
  - Spending restraint in the January 2024 mid-term budget review expected to more than offset lower-than-expected revenue collection, leading to an improvement in the primary balance of +0.7 percent of GDP in FY2023/24.
- Capacity and vulnerabilities:
  - Hydropower generation capacity currently at 3000 MW; projected to double within next four years and triple in the medium term (based on latest power purchase agreements data).
  - Domestic political uncertainty is a headwind to growth and a risk to policy continuity.
  - Nepal remains vulnerable to natural disasters and climate shocks.

### Outlook and risks
- Growth outlook:
  - Real GDP growth projected to rebound to 4.9 percent in FY2024/25, close to potential, driven by pickup in public investment and recovery in domestic demand.
- Inflation outlook:
  - Projected to remain within the NRB’s target ceiling of 5.5 percent for FY2024/25 and beyond.
- External outlook:
  - Imports expected to revive over time as pent-up demand and higher execution of public and private capital expenditure (especially in energy) materialize.
  - Slower remittance growth and a pickup in imports expected to further normalize reserves and align external position with fundamentals over the medium term.
- Key risks (domestic and external):
  - Elevated and interlinked risk of political volatility and weak policy execution.
  - Failure to raise execution rate of capital projects would deprive the economy of stimulus and weigh on medium-term growth.
  - Intensification of financial vulnerabilities: further rise in NPLs, weak capitalization, or failures among cooperative lenders (SACCOs) could endanger banking system soundness.
  - Continued large emigration for work and education could reduce labor force and dampen demand.
  - External shocks: high commodity prices and trade restrictions in partner economies could slow recovery in energy-intensive sectors, aggravate food insecurity, and impose fiscal costs.

### Program performance and reform implementation
- Program status:
  - Program performance broadly on track despite uncertain political environment.
  - All but one quantitative metric met.
- Quantitative targets:
  - Performance criteria (PCs) on net international reserves (floor) and primary fiscal deficit (ceiling) were met.
  - All continuous PCs were met.
  - Indicative target (IT) on child spending (floor) was missed due to technical difficulties in transitioning to a new electronic payment system; authorities committed to closely monitor the new transfer mechanism with the goal to achieve full execution of the child grant budget by end-FY2023/24.
- Structural benchmarks (SBs):
  - Three out of five SBs completed (two met), some progress on the remaining two proposed to be reset.
  - Achievements: on-site module of Supervisory Information System (SIS) for class A banks implemented; National Planning Commission approved the Public Investment Management Assessment (PIMA) action plan; Domestic Revenue Mobilization Strategy approved by Finance Ministry in early June.
  - Loan Portfolio Review (LPR): procurement of international advisors started late but now in full swing; launch expected end-August 2024 (new proposed date for the SB).
  - Amendments to the NRB Act under discussion to reflect 2021 Safeguards Assessment recommendations; proposed reset of related SB to end-September 2024 to allow more time for technical discussions before Parliament submission.
  - Progress also notable for SBs of the 5th review.

### Policy recommendations
- Fiscal policy
  - Execute the planned increase in capital spending as envisaged in the FY2024/25 budget while maintaining fiscal discipline through:
    - Domestic revenue mobilization.
    - Rationalization of current spending.
  - Strengthen public investment management to enhance efficiency of capital spending.
  - Advance fiscal transparency to bolster medium-term fiscal sustainability.
  - Support the most vulnerable:
    - Full execution of the child grant budget.
    - Future expansion of the program to all districts.
  - Budget specifics:
    - Staff projects an increase in the revenue-to-GDP ratio of about 1.0 pp of GDP in FY2024/25 (relative to 3.7 percent in the new budget), reflecting import recovery and gains from ongoing tax reforms.
    - Fiscal deficit projected to decline to 4.1 percent of GDP in FY2024/25 (compared to 4.6 in the 3rd review).
  - Tax measures included in FY2024/25 budget:
    - Introducing a green tax on petroleum products.
    - Adjusting tax structures to raise rates on electric and conventional vehicles.
    - Increasing excise duties on alcohol, beer, and tobacco.
    - Improving tax compliance.
    - Measures partially offset by reduction/elimination of duties on some raw materials and intermediate goods and reinstating VAT exemptions on potatoes, onions, and a few other agricultural products.
- Monetary and financial sector policies
  - Maintain the current cautious, data-driven monetary policy approach to preserve price and external stability.
  - Avoid further boom-bust credit cycles to establish a more stable, pro-growth equilibrium.
  - Maintain reforms on lending practices and asset classification while strengthening bank capitalization levels as the loan portfolio review of the ten largest banks advances.
  - Swiftly implement plans to address increasing vulnerabilities in SACCOs, including reforming the supervisory framework and architecture.
- Governance and structural reforms
  - Improve the anti-money laundering/combatting 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.
    - Recent law amendments are an important step forward and should be accompanied by needed secondary legislations and effective implementation.
  - Implement 2021 IMF Safeguards Assessment recommendations regarding the NRB Act and the NRB external audit; these remain a priority.

*Approved by Rupa Duttagupta (APD) and Fabian Valencia (SPR); discussions took place in Kathmandu during May 22-June 5, 2024.*

### 9.      The deficit level in the FY2024/25 budget is consistent with program objectives of

### 9.      The deficit level in the FY2024/25 budget is consistent with program objectives of gradual fiscal consolidation to stabilize public debt at a low risk of distress.

### Fiscal consolidation and public debt outlook
- A gradual fiscal consolidation is planned: primary deficit reduced from 3.0 percent of GDP FY  2023/24 to 2.5 percent in FY2024/25 and further to 1.1 percent in FY2028/29.
- Both public and external debts are assessed at low risk of debt distress (Debt Sustainability Analysis).
- Owing to the larger-than-anticipated fiscal consolidation in FY  2023/24, public debt is on track to stabilize at 50 percent of GDP by FY2026/27, a year earlier than projected in the 3rd review.
- The share of external financing is projected to remain below pre-pandemic levels.

### Domestic revenue mobilization, public investment, and social support
- Implementing the domestic revenue mobilization strategy (DRMS) (end-April 2024 SB, not met, approved June 2024) will help boost tax revenue through enhancements in tax administration and base broadening measures.
- The forecasted 1.0 percentage points of GDP rise in tax revenue for FY2024/25 mainly results from:
  - rebound in imports: 0.7 percentage points,
  - new tax measures: 0.2 percentage points,
  - tax administration improvements: 0.1 percentage points.
- Fund TA-based estimates: full implementation of the revenue mobilization effort could raise 3.7-4.1 percentage points of GDP of additional revenue over five years.
- Major reform components identified in the DRMS include:
  - Value added tax: broadening tax base; adopting a single, high compulsory registration threshold; removing the exemption on capital inputs while keeping a single positive rate.
  - Excise tax: simplifying the regime to limit excise to tobacco, alcohol, sugar, and single-use plastics; introducing excises on fuels, vehicles, coal, and cement that approximate their external costs.
  - Personal income tax: broadening the tax base and enhancing income tax progressivity.
  - Corporate income tax: removing tax holidays; curtailing tax incentives; introducing a minimum alternative tax; reducing tax rates; allowing full expensing for capital expenditure and indefinite carry forward of losses.
  - Property tax: increase property tax rates and periodically revise threshold exemptions; impose green tax on petroleum products, plastic items, coal with specific rates indexed to inflation; rationalize income tax incentives.
- DRMS tax administration measures to be implemented: improve ICT use, HR management, risk-based compliance; develop fully automated audit selection module; design automated risk-based selectivity module for import declarations; undertake tax audits of selected taxpayers; reform staff transfer norms; collaborate with local governments to improve property tax collection.
- To boost growth: ensure sustained increase of public capital spending, leveraging external concessional financing, particularly project loans.
- Based on the approved PIMA action plan (end-April 2024 SB, met), authorities intend to:
  - revise National Project Bank Operational Procedures and Unified Directives related to project development to enable more robust design, prioritization, and selection of projects based on systematic appraisal (end-March 2025 SB).
  - update and link the National Project Bank Management Information System (NPBMIS) with the Line Ministries Budget Information System (LMBIS) and the Provincial Project Bank Management Information System; include all multi-year projects in the project bank for monitoring and budgeting.
- Social protection: authorities should ensure full execution of child grant budgets in the near-term and endeavor to extend coverage from 25 districts to all 77 districts.
- Contingency planning to respond quickly to shocks (including earthquakes) remains essential.

### Fiscal transparency, public enterprises, and fiscal risk management
- Authorities are enhancing initial estimates of customs duty exemptions to be included in the comprehensive report on tax expenditure (previous SB) and non-customs-related tax exemptions (VAT, CIT, and PIT; previous SB).
- To publish a comprehensive report on tax expenditures (end-January 2025 SB), authorities will leverage IMF TA to cover customs tax expenditures.
- Including tax allowances, credits, deferrals, and reliefs in addition to tax exemptions in the report would guide future tax reforms.
- Fiscal risk disclosures:
  - A fiscal risk section is published in the Fiscal Policy Statement of the FY2024/25 budget, building on the fiscal risk registry.
  - The Finance Ministry plans to prepare and publish a comprehensive fiscal risk statement with the FY2025/26 budget (end-August 2025 SB).
- Public enterprises (PEs):
  - Authorities are preparing to publish FY2022/23 annual financial statements of all majority- and wholly-owned PEs by August 2024 (end-August 2024 SB).
  - Audits of three of the four priority nonfinancial PEs (Nepal Electricity Authority, Nepal Oil Corporation and Nepal Telecom) have been published; authorities committed to complete the audit of Nepal Airlines by end-August 2024 (end-August 2024 SB).
- Treasury and extrabudgetary units:
  - New cash flow forecasting framework (previous SB) and IMF TA intended to improve budget realism and reduce negative Treasury Single Account (TSA) balances.
  - Authorities included 88 extrabudgetary units (EBUs) at the Federation level and 5 EBUs at the provincial level in the FY2022/23 FCGO annual financial statements and are making progress to include all EBUs in the FY2023/24 financial statements.
  - FCGO inclusion thresholds: government non-budgetary entities with annual income or expenditure > NPR 50 million; provincial entities > NPR 20 million; local levels > NPR 5 million.

### Monetary policy and market functioning
- Monetary policy de facto shifted to a looser stance: effective target moved from midpoint of the interest rate corridor (IRC) to the bottom.
- With the reduction in December 2023 of the bottom of the corridor by 150 basis points, the de facto target rate has fallen by about 400 basis points since July 2023.
- Credit market disruption and interest rate-setting regulations delayed transmission into credit growth, though lending rates have come down approximately 200 basis points as of May 2024.
- In April 2024, the Finance Ministry ended the policy of counting local government bank deposits in the calculation of deposits, causing a fall of about 10 percent of money supply.
- Implementing the monetary policy IRC framework would improve market function regardless of stance:
  - Active intervention to target keeping the interbank rate at the midpoint will support clarity and credibility.
  - With ample liquidity, the de facto target rate may need to rise if inflationary pressures return; macroprudential measures are needed to avoid excessive credit expansion.
- Deposit Collection Facility introduced in February 2024 to absorb liquidity at the bottom of the IRC significantly reduced dips of the interbank rate below the IRC.
- Improved cash flow forecasting by the Finance Ministry—with upcoming IMF TA—will allow greater coordination on TSA use and help the NRB calibrate monetary operations.

### Financial sector vulnerabilities and bank supervision
- Banking adjustments after post-pandemic credit boom: reclassifying loans and absorbing losses have increased gross NPLs.
- Regulatory changes: working capital loan guideline improvements in 2022 and asset classification regulation in 2023 led to a shift to term lending but higher gross NPLs.
- NRB phased out forbearance on restructuring and rescheduling loans in mid-April.
- Provisioning and capital:
  - Banking system aggregate coverage ratio: 70 percent.
  - Aggregate Tier-1 capital ratio of commercial banks: decreased from 10.2 in April 2023 to 9.7 percent in April 2024 relative to the current regulatory minimum of 8.5 percent.
  - Minimum capital requirement includes 8 percent minimum and a counter-cyclical buffer of 0.5 percent.
  - Two small commercial banks do not meet the capital requirement by a small margin and are undertaking remedial actions.
- NRB considering policies to facilitate issuance of capital instruments; alignment with international standards is important to avoid banks financing acquisition of their own capital instruments.
- A likely decrease of the counter-cyclical buffer in FY2024/25—based on NRB’s data-driven approach—would provide some relief.
- NRB actions:
  - Preparing a loan portfolio review (LPR) for the ten largest banks: TOR agreed with staff in February 2024; procurement of an international independent consultant started late but ongoing.
  - Proposed schedule: launch LPR end-August 2024 (reset from end-April 2024 SB); conclude consultant work by end-February 2025 (reset from end-December 2024 SB); finalize roadmap outlining NRB’s approach by end-February 2025.
  - LPR expected to inform reforms related to the bank resolution framework consistent with 2023 FSSR recommendations.
- Supervision enhancements with IMF TA:
  - Implementation of on-site module of the Supervisory Information System (end-April SB, met) completed.
  - Reintroduction of the counter-cyclical buffer following a two-year suspension.
  - Progressing with plans to introduce NFRS 9 and implement expected credit loss modeling in the next fiscal year.
  - Finalizing policy framework for Basel III liquidity coverage ratio (LCR) with view to implement in FY2024/25.
  - Workplan to implement 2023 FSSR recommendations: develop off-site analytical tools, improve credit risk supervisory practices, and strengthen consolidated supervision.

### Savings and cooperative sector (SACCOs) risks and reforms
- Recent collapses of several SACCOs in the last six months caused loss or freeze of client savings and small-scale social unrest.
- SACCO sector scale and risk:
  - Over 14,000 SACCOs holding estimated NPR 478 billion of savings deposits—1/12th the size of banking sector deposits in June 2023—raising risk of negative spillovers to other SACCOs and smallest regulated banks.
- Main causes of failures: investment in illiquid and underperforming assets, impacting repayment capacity, and some cases of fraud.
- Authorities’ measures and recommended strategy:
  - Suspended registration of new SACCOs and considering reforms.
  - Strategy should facilitate cleanup of problematic SACCOs, ensure central coordination of the 761 district and provincial SACCO regulators, reform supervisory and regulatory architecture, and prioritize remedying large data gaps, triaging problematic institutions, and implementing strategies to deal with them.
  - Ensure largest financially sound SACCOs remain stable and appropriately regulated while addressing problematic SACCOs.
  - Expedite reforms including establishment of a specialized regulatory authority to collect data, regulate and supervise financial cooperatives and re-license SACCOs.

### Governance, AML/CFT, and structural reforms to boost growth
- NRB Safeguards Assessment (2021) implementation: of 16 recommendations, eight fully implemented; progress on remaining recommendations is slow.
  - Draft amendments to NRB Act have been worked on to align with SGA recommendations (end-April 2024 SB, not met, reset to September 2024).
  - For audit of FY2023/24 NRB financial statement, authorities agreed to involve experts with international central bank auditing experience (end-July 2024 SB, modified).
- AML/CFT:
  - Government passed amendments to AML/CFT laws and is producing a national strategy to address deficiencies.
  - Staff will assess whether amendments align sufficiently with FATF standards (end-July 2024 SB).
  - ICRG observation period ends in October 2024, followed by possible public identification (“grey listing”) and formal FATF review; deficiencies could lead to reputational risks and impact access to the financial system.
- Business climate and structural reforms:
  - Priorities: strengthen economic governance and anticorruption institutions; accelerate market deregulation and digitalization to improve business climate and increase investment.
  - Measures to enhance growth and competition: full implementation and enforcement of the Competition Act; enhance contract and property rights enforcement; improve public investment efficiency via PIMA Action Plan; modernize regulatory framework and strengthen fiscal federalism; facilitate trade diversification.
  - Progressive digitalization of government and judicial administration and services to promote transparency and reduce corruption.
  - FDI would benefit from deregulation, including removal of burdensome regulatory approvals and restrictions on foreign investment in consultancy services, agriculture, and tourism sectors.
  - The recently approved 16th Development Plan prioritizes improving agricultural and food security, investing in climate adaptation, expanding social safety nets, enhancing productivity, and supporting job creation in the agricultural sector, and improving targeted social protection schemes (MEFP ¶15, ¶27).

### Program modalities and capacity to repay
- IMF credit outstanding is projected to peak at 14.8 percent of exports and 1.1 percent of GDP in FY2024/25 (Table 9).
- Nepal’s outstanding credit to the IMF relative to key macroeconomic metrics remains low compared to other UCT arrangements of PRGT-eligible countries, while debt service indicators fall within the interquartile range of the comparator group.
- The authorities’ track record of servicing IMF debt is strong.

*Source: 1nplea2024001-print-pdf - 9.      The deficit level in the FY2024/25 budget is consistent with program objectives of*

### 22.      The program is fully financed, with firm commitments in place for the next 12 months.

### 1nplea2024001-print-pdf - 22.      The program is fully financed, with firm commitments in place for the next 12 months.

### Financing and commitments
- The program is fully financed, with firm commitments in place for the next 12 months.
- Even though budget support financing in FY2022/23 was lower than projected, pledges for FY2023/24 through FY2024/25 are above the level recorded during the third review.
- The authorities intend to use the ECF arrangement for budget support.
- Note: Current baseline forecast is as of June 10, 2024.

### Projected financing gap (Text Table 2) — Selected figures
- External financing requirement: -2.7 (FY2023/24), 1.5 (FY2024/25)
- Current account deficit1/: -2.6 (FY2023/24), 2.2 (FY2024/25)
- Financing sources: -3.5 (FY2023/24), 0.6 (FY2024/25)
- Foreign borrowing: 1.4 (FY2023/24), 1.4 (FY2024/25)
- Current and capital grants: 0.9 (FY2023/24), 0.9 (FY2024/25)
- FDI, net: 0.2 (FY2023/24), 0.3 (FY2024/25)
- Change in reserves (+ decrease): -6.1 (FY2023/24), -2.1 (FY2024/25)
- External financing gap: 0.8 (FY2023/24), 0.9 (FY2024/25)
- Total revenue and grants: 19.3 (FY2023/24), 20.2 (FY2024/25)
- Expenditure: 24.0 (FY2023/24), 24.4 (FY2024/25)
- Fiscal deficit: 4.7 (FY2023/24), 4.1 (FY2024/25)
- Total financing: 3.8 (FY2023/24), 3.3 (FY2024/25)
- Net acquisition of financial assets: 1.3 (FY2023/24), 1.3 (FY2024/25)
- Net incurrence of liabilities: 5.1 (FY2023/24), 4.6 (FY2024/25)
- Foreign borrowing (fiscal financing need): 0.7 (FY2023/24), 0.7 (FY2024/25)
- Domestic borrowing: 4.4 (FY2023/24), 3.8 (FY2024/25)
- Fiscal financing gap: 0.8 (FY2023/24), 0.9 (FY2024/25)
- Financing commitments so far: 0.8 (FY2023/24), 0.9 (FY2024/25)
  - IMF: ECF 0.2 (FY2023/24), 0.2 (FY2024/25)
  - Asian Development Bank 0.3 (FY2023/24), 0.3 (FY2024/25)
  - World Bank 0.3 (FY2023/24), 0.4 (FY2024/25)
1/ Current account excludes official transfers.

### Prospects and near-term needs
- Near-term external financing needs are projected to be lower than during the 3rd review because of smaller-than-expected current account deficits.
- Prospective financing needs remain, as the current account deficit is projected to widen in the medium term.

### Risks and shock scenarios
- Key risks:
  - Political instability and weaker commitment to reforms could jeopardize policy continuity and program implementation.
  - A large adverse commodity price shock would likely require monetary policy tightening and fiscal restraint.
  - A significant reduction in remittances could lead to a decline in growth, reserves, and revenues.
  - A large decline in remittances and/or a large natural disaster would require greater external support from development partners to avoid unsustainable fiscal outcomes.
- Mitigants:
  - Reserve growth has provided a backstop; the strengthened reserve position provides an increasingly potent backstop to external shocks.
  - The program includes some flexibility through adjustors on program fiscal targets.
  - The NRB has been maintaining tight regulatory measures, developing liquidity facilities, and stands ready to provide liquidity support to prevent wider systemic concerns.
  - The NRB plans to enable banks to raise more capital to help stave off public anxiety about banking sector capitalization and soundness.
- Fiscal guidance in stress:
  - Spending restraint in response to potential revenue underperformance should protect public investment and social spending.
  - Any systemic event may require government intervention with significant fiscal implications, but intervention should ensure that investors bear the burden of costs and that unanticipated fiscal space be prioritized to public investment.

### Capacity development (CD) and technical assistance
- CD remains well aligned with program objectives and will continue to support program implementation.
- Recent CD priorities:
  - Development of the DRMS and PIMA action plan.
  - Implementation of the 2021 SGA recommendations.
  - Improvements in revenue administration.
  - Preparation of a tax expenditure report for the next review.
- Fund and SARTTAC CD underway:
  - Improve statistics (mostly national accounts).
  - Strengthen the monetary policy implementation framework.
  - Ensure sustainability of reforms implemented under previous reviews, such as cashflow forecasting.
- Prospective CD:
  - Focus on program and SGA implementation, strengthening the financial sector, and developing a road map for FSSR recommendations.
  - Fund TA to enhance the AML/CFT framework and promote compliance with international standards.

### Staff appraisal — Growth, program performance, and policy recommendations
- Growth outlook:
  - Real GDP growth is projected to rebound to 4.9 percent in FY2024/25, driven by a pickup in public investment and recovery in domestic demand.
  - Although the external position was stronger than implied by fundamentals in FY2023/24, it is projected to weaken as imports revive and remittances slow.
- Program performance:
  - PCs on net international reserves and the primary fiscal deficit were met, together with all standard continuous PCs.
  - Only the IT on child allowance spending was missed.
  - Three of five SBs completed (two met).
- Fiscal policy recommendations:
  - Swiftly implement the recently approved DRMS.
  - Pursue rationalization of current spending, enhance capital outlays, and protect the most vulnerable.
  - Expedite tax policy and administration measures in the DRMS and accelerate planned reviews to identify additional reform measures.
  - Curtail spending duplication with subnational governments and rationalize unnecessary administrative costs.
  - Prioritize social spending, especially child grants.
  - Execute the planned increase in capital expenditure in the FY2024/25 budget, leveraging external concessional financing.
  - Improve public investment efficiency by implementing the approved PIMA action plan.
  - Closely monitor fiscal risks and enhance fiscal transparency.
- Monetary policy recommendations:
  - Maintain an appropriately cautious and data-driven approach focused on preserving price and external stability.
  - Continue improving the toolkit to implement the IRC and use discretionary intervention more actively, backed by clear authority and commitment.
- Financial sector recommendations:
  - Vigilant and proactive approach to curb vulnerabilities: align regulations on asset classification and lending with international standards.
  - Continue close monitoring of banks and develop policies to facilitate their capitalization.
  - Use the LPR to improve visibility on potential asset quality issues and test the Supervisory Information System.
  - Implement scheduled financial sector reforms on capital and liquidity standards.
  - Expedite a cohesive strategy to resolve problematic SACCOs, safeguard sound large SACCOs, and reform regulatory and supervisory architecture.
- Institutional recommendations:
  - Implement the 2021 SGA recommendations, including conducting the NRB audit with international experts and submitting to Parliament amendments to the NRB Act to safeguard operational and financial independence.
  - Strengthen the AML/CFT framework by implementing reforms identified by the APG in its mutual evaluation report.

### Program endorsement
- Staff supports the completion of the fourth review of the ECF-supported program and the disbursement of fifth tranche in the amount of SDR 31.4 million.

*Source: IMF staff report (current baseline forecast as of June 10, 2024).*

### 13.2 percent y-o-  y, respectively, in April 2024...

### 1nplea2024001-print-pdf - 13.2 percent y-o-  y, respectively, in April 2024...

### Monetary and Credit Developments
- Broad money growth: 12.9 percent (y-o-y) in April 2024, largely due to net foreign asset accumulation.
- Deposit and credit dynamics:
  - High deposit growth and low credit growth led to excess liquidity, although not very high by recent historical standards.
  - Interbank rates: kept at the bottom of the interest rate corridor in a context of weak liquidity absorption.
- Private sector credit:
  - Private sector credit growth remains in single digits, essentially only keeping up with inflation.
  - Private sector credit-to-GDP ratio: remains among the highest in its peer group.
- Selected money and credit series (annual percent change) from Table 1:
  - Broad money: 21.8; 6.8; 11.4; 12.5; 10.4; 10.8; 11.7; 10.5; 10.6; 10.7; 10.7
  - Domestic credit: 26.8; 17.9; 8.8; 8.8; 11.3; 9.3; 11.2; 9.4; 10.1; 10.5; 10.7
  - Private sector credit: 26.3; 13.3; 4.6; 5.5; 8.6; 7.8; 8.8; 8.2; 9.5; 10.3; 10.6
- Private sector credit (in percent of GDP) from memorandum: 95.1; 94.2; 91.7; 89.3; 89.4; 87.2; 87.1; 85.3; 84.4; 84.1; 84.1

### External Sector Developments
- FY2022/23 current account deficit: shrank on the back of import contraction and strong remittances.
- Imports:
  - Continued to contract in FY2023/24 on a year-on-year basis, albeit at a decreasing rate.
  - Decrease driven mainly by manufactured goods and equipment.
  - Imports of goods (y/y percent change) from Table 1: 25.7; 21.9; -22.0; -1.8; 9.6; 23.1; 15.5; 14.9; 5.9; 5.6; 5.7
- Exports:
  - Exports have rebounded since 2020, but remain well below the 1990-2009 levels, and below peers.
  - Exports of goods (y/y percent change) from Table 1: 30.0; 43.9; -19.9; -0.7; 5.4; 14.0; 9.3; 9.5; 9.3; 10.0; 9.4
- Remittances and tourism:
  - Foreign employment of Nepalis remains resilient, driving robust growth in remittances.
  - Workers' remittances (in millions of U.S. dollars) from Table 1: 8,150; 8,326; 9,330; 10,679; 9,967; 11,141; 10,356; 11,623; 12,126; 12,651; 13,199
  - Workers' remittances (in percent of GDP) from Table 1: 22.1; 20.2; 22.8; 24.5; 21.7; 23.3; 20.3; 22.1; 20.9; 19.8; 18.7
  - Tourism: rebounding, approaching pre-pandemic levels.
- Trade balance and reserves:
  - Trade balance (in millions of U.S. dollars) from Table 1: -11,510; -13,759; -10,699; -10,492; -11,813; -13,037; -13,735; -15,067; -15,904; -16,711; -17,580
  - Gross official reserves (in millions of U.S. dollars) from Table 1: 10,884; 8,973; 10,974; 13,564; 12,674; 14,582; 13,225; 14,565; 14,399; 14,398; 14,578
  - Gross official reserves (in months of prospective imports) from Table 1: 7.5; 7.6; 9.2; 9.4; 8.4; 8.8; 8.3; 8.3; 7.8; 7.3; 7.0
- Current account (in millions of U.S. dollars) and percent of GDP from Table 1:
  - Current account: -2,844; -5,174; -557; 1,409; -721; -775; -2,015; -2,100; -2,312; -2,419; -2,523
  - In percent of GDP: -7.7; -12.6; -1.4; 3.2; -1.6; -1.6; -4.0; -4.0; -4.0; -3.8; -3.6

### Recent Fiscal Developments
- FY2022/23 fiscal deficit: widened to 5.8 percent of GDP driven by a sizable drop in revenue collection.
- Total public debt: increased to 46.9 percent of GDP in FY2022/23.
- Revenue and tax trends:
  - Lower tax collection drove the sharp fall in total fiscal revenue in FY2022/23.
  - Taxes from several sources declined, with the largest decline in VAT, customs, and excise duty.
  - The tax revenue decline in FY2022/23 was mostly driven by a sharp drop in import-related tax revenues.
- Expenditures:
  - Current and capital expenditure were contained in the context of low revenue collection in FY2022/23.
- Central government fiscal aggregates from Table 1 (selected):
  - Net lending/borrowing (percent of GDP): -4.0; -3.1; -5.8; -4.7; -5.3; -4.1; -4.6; -3.6; -3.2; -2.9; -2.7
  - Total revenue and grants (percent of GDP): 23.3; 22.9; 19.3; 19.3; 19.8; 20.2; 20.8; 21.4; 22.1; 22.7; 23.2
  - Tax revenue (percent of GDP): 20.0; 19.8; 16.2; 16.4; 16.5; 17.4; 17.6; 18.3; 19.0; 20.2; 20.2
  - Expenditure (percent of GDP): 27.2; 26.1; 25.2; 24.0; 25.1; 24.4; 25.4; 25.0; 25.3; 25.7; 25.9
  - Public debt (in percent of GDP) from memorandum: 43.3; 42.7; 47.1; 49.7; 48.4; 50.4; 49.3; 50.4; 49.3; 48.4

### Socio-Economic Indicators and Living Standards
- Income and poverty:
  - Nepal is one of the lowest income countries in Asia and South Asia, yet poverty has fallen significantly in the last decade.
  - The decline in poverty is reflected in an improvement in Nepal’s UNDP Human Development Index.
- Human capital and living standards:
  - Although human capital levels are similar to comparators, there is scope for improvement.
  - There is substantial scope and need to improve living standards, including relating to hunger.
- Remittances as safety net:
  - One of Nepal’s most important safety nets comes from remittances.

### Climate Change, Pollution, and Energy
- Climate and shocks:
  - Average temperatures have risen in Nepal.
  - The country is subject to significant and growing climate related shocks including landslides, floods, and storms.
- Emissions and energy:
  - Total GHG 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 good.
- Pollution:
  - Pollution is trapped by Nepal’s mountainous geography making it the 9th most polluted country, and Kathmandu is the 11th most polluted capital city.

### Capacity to Repay and Debt Relief
- CCRT debt relief (memorandum): 7.1; 3.6 (reported in Table 1 note and CCRT entries).
- Net international reserves (in millions of U.S. dollars) from memorandum: 10,620; 8,821; 10,528; 13,081; 12,146; 14,024; 12,623; 14,012; 13,899; 13,962; 14,222

### Projections and Medium-Term Outlook (selected series)
- Real GDP (annual percent change) row in Table 1 shows multiple entries consistent with staff projections (table formatting preserved).
- Headline CPI (period average) from Table 1: 3.6; 6.3; 7.8; 5.6; 7.3; 5.2; 6.2; 5.4; 5.4; 5.4; 5.4
- Nominal GDP (in billions of U.S. dollars) from memorandum: 36.9; 41.2; 40.9; 43.7; 45.9; 47.8; 50.9; 52.6; 58.0; 63.9; 70.4
- Fiscal projections (selected, in billions of Nepalese Rupees) from Table 2a:
  - Total revenue and grants: 1,013; 1,141; 1,034; 1,119; 1,472; 1,294; 1,511; 1,730; 1,966; 2,220
  - Expenditure: 1,186; 1,297; 1,346; 1,390; 1,652; 1,559; 1,765; 1,982; 2,221; 2,481
  - Net lending/borrowing (billions of rupees): -173; -155; -312; -271; -180; -265; -254; -252; -255; -261
  - Primary balance (billions of Nepali Rupees): -138; -110; -239; -173; -77; -158; -141; -125; -114; -104
  - Primary balance (in percent of GDP): -3.2; -2.2; -4.5; -3.0; -1.2; -2.5; -2.0; -1.6; -1.3; -1.1

*Source: IMF staff estimates and projections (current baseline forecast as of June 10, 2024).*

### 3.6 million was approved on April 1, 2021.  The fourth and fifth (final) tranche of CCRT debt service relief covering th

### 1nplea2024001-print-pdf - 3.6 million was approved on April 1, 2021.  The fourth and fifth (final) tranche of CCRT debt service relief covering th

### CCRT debt service relief chronology
- First tranche: covering April 14, 2020 to October 13, 2020 for SDR 2.9 million; approved on April 13, 2020.
- Second tranche: covering October 14, 2020 to April 13, 2021 for SDR 3.6 million; approved on October 2, 2020.
- Third tranche: covering April 14, 2021 to October 15, 2021 for SDR 3.6 million; approved on April 1, 2021.
- Fourth tranche: covering October 16, 2021 to January 10, 2022 for SDR 3.6 million; approved on October 6, 2021.
- Fifth (final) tranche: covering January 11 to April 13, 2022 for SDR 3.6 million; approved on December 15, 2021.
- Note: Nepal received debt relief of SDR 3.6 million in FY2020/21 covered by grants from the CCRT.

### Balance of Payments: key projection snapshots (selected items, in millions of US dollars unless noted)
- Current Account levels (2021/22 onward): -2,844; -5,174; -557; 1,409; -721; -775; -2,015; -2,100; -2,312; -2,419; -2,523.
- Current account (excluding official transfers): -3,052; -5,312; -657; 1,147; -1,142; -1,062; -2,470; -2,566; -2,814; -2,929; -3,086.
- Trade balance: -11,510; -13,759; -10,699; -10,492; -11,813; -13,037; -13,735; -15,067; -15,904; -16,711; -17,580.
- Exports, f.o.b.: 1,219; 1,754; 1,406; 1,396; 1,481; 1,591; 1,619; 1,743; 1,905; 2,095; 2,292.
- Imports, f.o.b.: -12,729; -15,513; -12,104; -11,888; -13,295; -14,628; -15,353; -16,810; -17,809; -18,806; -19,872.
- Services (net): -618; -893; -642; -557; -664; -600; -530; -646; -667; -640; -673.
- Receipts (services): 671; 1,008; 1,439; 1,888; 1,803; 2,116; 2,204; 2,343; 2,524; 2,782; 3,067.
- Tourism receipts (of which): 62; 684; 706; 556; 899; 099; 681; 1,052; 1,159; 1,278; 1,409. 
- Payments (services): -1,290; -1,901; -2,081; -2,445; -2,466; -2,716; -2,734; -2,990; -3,190; -3,422; -3,739.
- Income (net): 198; 238; 476; 707; 425; 488; 392; 484; 475; 524; 578.
- Current transfers (credit, of which): 9,137; 9,305; 10,368; 11,806; 11,390; 12,436; 11,923; 13,196; 13,858; 14,489; 15,242.
- Workers' remittances: 8,150; 8,326; 9,330; 10,679; 9,967; 11,141; 10,356; 11,623; 12,126; 12,651; 13,199.
- Financial Account (total): 2,139; 2,546; 1,551; 1,087; 2,222; 1,638; 2,352; 1,868; 1,909; 2,178; 2,437.
- Direct investment: 166; 155; 456; 618; 816; 731; 123; 726; 128; 831; 317.
- Other investment (net): 1,974; 2,391; 1,506; 1,022; 2,034; 1,471; 2,041; 1,631; 1,648; 1,890; 2,120.
- Of which: Official loans: 881; 760; 516; 685; 822; 763; 694; 794; 688; 738; 852.
- Overall Balance: 146; -1,533; 2,137; 2,646; 1,741; 1,013; 573; 0; -151; 141; 95.
- Current Account (percent of GDP): -7.7; -12.6; -1.4; 3.2; -1.6; -1.6; -4.0; -4.0; -4.0; -3.8; -3.6.
- Trade balance (percent of GDP): -31.2; -33.4; -26.2; -24.0; -25.7; -27.3; -27.0; -28.6; -27.4; -26.1; -25.0.

### Memorandum and external adequacy indicators
- Remittances (y/y percent change): 8.2; 2.2; 12.1; 14.5; 6.8; 4.3; 3.9; 4.3; 4.3; 4.3.
- Total external debt (percent of GDP): 25.5; 24.9; 26.4; 25.7; 26.1; 25.4; 25.6; 25.0; 24.3; 23.8; 23.4.
- Gross official reserves (mil U.S. dollars): 10,884; 8,973; 10,974; 13,564; 12,674; 14,582; 13,225; 14,565; 14,399; 14,398; 14,578.
- Gross official reserves (months of prospective imports): 7.5; 7.6; 9.2; 9.4; 8.4; 8.8; 8.3; 8.3; 7.8; 7.3; 7.0.
- Net international reserves (mil U.S. dollars): 10,620; 8,821; 10,528; 13,081; 12,146; 14,024; 12,623; 14,012; 13,899; 13,962; 14,222.
- Nominal GDP (in mil U.S. dollars): 36,927; 41,183; 40,907; 43,673; 45,911; 47,826; 50,950; 52,622; 57,968; 63,907; 70,443.
- Note: Current baseline forecast is as of June 10, 2024. Fiscal year ends mid-July.

### Nepal Rastra Bank and monetary aggregates (selected levels and percent changes)
- Reserve money (NRB, end-period, in billions of NPR): 932; 826; 912; 9? (table shows formatting issues) — also lines: 761,021,1,040,1,107 appear in row but source formatting ambiguous.
- Net domestic assets (NRB): -367; -319; -528; -844; -635; -914; -633.
- Net foreign assets (NRB): 1,299; 1,145; 1,440; 1,821; 1,656; 1,954; 1,740.
- Broad money (Monetary Survey): 5,155; 5,505; 6,130; 6,896; 6,769; 7,638; 7,563.
- Narrow money: 1,049; 948; 947; 1,362; 1,337; 1,508; 1,493.
- Quasi-money: 4,105; 4,557; 5,184; 5,535; 5,433; 6,130; 6,069.
- Domestic credit: 4,811; 5,672; 6,169; 6,713; 6,868; 7,340; 7,636.
- Credit to public sector: 671; 983; 1,266; 1,540; 1,541; 1,763; 1,843.
- Credit to private sector: 4,140; 4,689; 4,903; 5,173; 5,326; 5,577; 5,794.
- Reserve money (percent change): 5.2; -11.4; 10.4; 7.1; 12.0; 6.5; 8.4.
- Broad money (percent change): 21.8; 6.8; 11.4; 12.5; 10.4; 10.8; 11.7.
- Nominal GDP (in billions of Nepalese Rupees, end-period): 4,353; 4,977; 5,349; 5,793; 5,957; 6,393; 6,653.
- Net international reserves (program definition, mil US$): 10,620; 8,821; 10,528; 13,081; 12,146; 14,024; 12,623.

### External financing requirements and sources (FY2022/23–2025/26, in millions of US dollars)
- Gross external financing requirements (2022/23 onward): -1,114; -1,168; 173; 697; 1,380; 2,138.
- Current account excluding official transfers (contribution to requirements): 657; -1,147; 1,142; 1,062; 2,470; 2,566.
- Amortization of medium- and long-term debt: 264; 316; 243; 343; 256; 409.
- Other net capital flows (- = outflow): 2,035; 337; 1,212; 709; 1,347; 837.
- Available financing (total): -1,337; -1,537; -246; 283; 1,146; 1,696.
- Current and capital grants: 198; 411; 661; 436; 691; 698.
- Medium- and long-term borrowing excluding exceptional financing: 557; 632; 646; 692; 717; 762.
- Change in reserves (+ = decrease): -2,137; -2,646; -1,741; -1,013; -573; 0.
- Financing gap / Exceptional/additional financing (same): 223; 369; 419; 414; 234; 442.
- Exceptional/additional financing contributors (selected): IMF: ECF arrangement 52.3; 94.1; 94.1; 83.7; 83.7; 41.8. Asian Development Bank: 75; 150; 125; 150; 50; 200. World Bank: 96; 125; 200; 180; 100; 200.
- Gross official reserves (mil US$, memorandum): 10,974; 13,564; 12,674; 14,582; 13,225; 14,565.
- In months of prospective imports (memorandum): 9.2; 9.4; 8.4; 8.8; 8.3; 8.3.
- Note: Current baseline forecast as of June 10, 2024. Fiscal year ends mid-July.

### Financial Soundness Indicators (FY2019/20–2023/24 Q3; selected)
- Regulatory capital to risk weighted assets: 14.16; 14.19; 13.58; 13.42; 12.59.
- Tier 1 capital to risk weighted assets: 12.01; 11.12; 10.81; 10.59; 9.78.
- NPLs to total gross loans: 1.89; 1.48; 1.31; 3.02; 3.98.
- Loan loss provisions to NPLs: 65.90; 70.24; 68.25; 62.17; 69.93.
- Credit to deposit ratio (from 2021/22): ...; ...; 86.22; 81.63; 80.88.
- Cash & bank balance to total deposits: 12.21; 19.51; 18.03; 8.05; 8.14.
- Total liquid assets to total deposits: 27.90; 26.18; 27.52; 27.10; 27.87.
- Share of real estate and housing loans: 12.71; 11.54; 12.01; 12.27; 12.46.
- Share of loans collateralized by fixed assets: 76.04; 74.71; 75.06; 76.87; 76.96.
- Overdraft (revolving loans): 14.93; 15.19; 15.25; 15.32; 15.38.
- Demand & working capital loans: 21.45; 21.09; 21.51; 18.04; 15.05.
- Sources: NRB; and IMF staff calculations.

### Current access and phasing under the Extended Credit Facility (SDR million and percent of quota)
- Board approval of the Arrangement (January 12, 2022): Available 78.50 SDR million; 50% of quota.
- First Review (June 12, 2022): Observance and completion — Available 19.60; 13% of quota.
- Second Review (January 12, 2023): Available 19.60; 13% of quota.
- Third Review (November 1, 2023): Available 39.20; 25% of quota.
- Fourth Review (May 1, 2024): Available 31.40; 20% of quota.
- Fifth Review (November 1, 2024): Available 31.40; 20% of quota.
- Sixth Review (May 1, 2025): Available 31.40; 20% of quota.
- Seventh Review (November 1, 2025): Available 31.32; 20% of quota.
- Total available: 282.42 SDR million; 180% of quota.
- Note: Nepal's quota is SDR 156.9 million.

### Quantitative Performance Criteria and Indicative Targets (selected items, FY2023/24)
- Primary deficit of the federal government (ceiling; in NPR million): Program target 435,959; Adjusted target 440,278; Outturn 178,827; Status: met (15-Jul-24 testing date).
- Stock of NRB's net international reserves (floor; in U.S. dollars million): Program target 8,038; Adjusted target 6,998; Outturn 10,473; Status: met (15-Jul-24 testing date).
- Accumulation of external payments arrears (ceiling): 0/0/0 met.
- Indicative target: federal government spending on child allowance (floor; in NPR million): 6,987; 6,987; Outturn 6,763; Status: not met (15-Jul-24); subsequent testing dates show not met at earlier outturns too.
- Budget support from development partners (memorandum, in U.S. dollars million): 330; 171; 162; 100; 325; 334; 493 (various testing dates and cumulative periods presented).
- Revenues of the budgetary central government under the program (in NPR million): 968,166; 838,029; 341,044; 438,939; ... (figures cumulative and noted as under program).
- Notes on adjustors and caps: NIR floor target for July 15, 2024 includes a margin about 0.8 months of imports; margin gradually reduced to 0.6 months for subsequent targets. Upward adjustment cap to primary deficit for revenue shortfalls NPR 61,009 for January 14, 2024 test date; adjustors to be phased out starting July 15, 2024 test date.

### Indicators of Capacity to Repay the Fund (FY2023/24–2036/37, selected)
- Fund obligations based on existing credit (millions of SDR): Principal by year: 7.1; 7.1; 3.4; 4.9; 3.9; 2.4; 7.1; 5.8; 8.8; 2.8; 3.1; 4.3; 5.7; 3.9; 0.0; 0.0; 0.0.
- Charges and interest (millions of SDR, selected): 3.2; 3.4; 3.4; 3.4; 3.5; 3.4; 3.4; 3.4; 3.5; 3.4; 3.4; 3.4; 3.5; 3.4.
- Total obligations based on existing and prospective credit (millions of SDR, selected): 10.3; 10.6; 38.4; 42.7; 50.5; 62.3; 75.6; 86.8; 52.1; 44.2; 32.5; 19.1; 6.6; 3.4.
- Billions of Nepali Rupees (total obligations): 1.8; 1.9; 6.9; 7.7; 9.1; 11.3; 13.8; 10.3; 9.5; 8.0; 5.9; 3.5; 1.2; 0.6.
- Percent of exports of goods and services (total obligations): 0.4; 0.4; 1.3; 1.3; 1.4; 1.6; 1.7; 1.2; 1.0; 0.8; 0.5; 0.3; 0.1; 0.0.
- Outstanding IMF credit based on existing and prospective drawings (millions of SDR, selected): 355.9; 411.6; 407.9; 368.7; 321.6; 262.8; 190.6; 137.3; 88.6; 47.8; 18.8; 3.1; 0.0; 0.0.
- Net use of IMF credit (millions of SDR): 63.5; 55.7; -3.6; -39.2; -47.1; -58.8; -72.2; -53.4; -48.6; -40.8; -29.0; -15.7; -3.1; 0.0.
- Memorandum items (exports of goods and services, millions of SDR): 2,468; 2,790; 3,069; 3,320; 3,649; 4,001; 4,396; 4,830; 5,307; 5,830; 6,406; 7,038; 7,733; 8,496.
- Note: Reporting year August to July.

### Structural Benchmarks (April 2022–August 2025): status and modifications (selected)
- Cross-cutting: Implementing agency publishes on a government website large public procurement documentation and related details consistent with December 2021 public information notice — Prior Action — Met.
- MOF publishes 4th CARES report including federal government COVID-19 expenditures on a government website — End-April 2022 — Met.
- FCGO reports consolidated financial information of all operational funds in annual financial statements starting FY2021/22 — End-January 2025 (status not indicated in excerpt).
- MOF submits to Parliament amendments to modernize the NRB Law (addressing 2021 Safeguards Assessment recommendations) — End-April 2024 — Not Met; Reset to end-September 2024.
- External audit of NRB financial statements for FY2021/22 — End-April 2022 — Not Met, Implemented September 2022.
- Audit of FY2023/24 NRB financial statements involving experts with international central bank auditing experience — End-July 2024 — Modified.
- MOF publishes report on tax exemptions for all non-customs taxes — End-August 2023 — Not Met, Implemented September 2023.
- MOF approval of a revenue mobilization strategy covering tax policy, law, and revenue administration reforms — End-April 2024 — Not Met, Implemented June 2024.
- MOF implements a fiscal risk register to capture major fiscal risks — End-August 2023 — Met.
- National Planning Commission approves an action plan to improve efficiency of public investment spending and strengthen climate resilience (PIMA recommendations) — End-April 2024 — Met.
- NRB enhancements to bank reporting template to monitor COVID-19 impact — End-April 2022 — Met.
- NRB drafts amendments to regulations on NPL identification and asset classification — End-April 2022 — Not Met, implemented May 2022.
- NRB issues updated regulation on asset classification — End-August 2023 — Met.
- NRB completes full implementation of the Supervisory Information System among class A, B and C banks, excluding onsite module — End-August 2023 — Met.
- NRB completes implementation of the onsite module of the SIS among class A banks — End-April 2024 — Met.
- NRB to complete in-depth on-site inspections for the 10 largest banks assisted by independent international third-party auditors — originally End-April 2024; Not Met; Reset to end-August 2024; further resets show End-December 2024 then Reset to end-February 2025.
- NRB finalizes roadmap outlining approach to outcome of in-depth on-site inspections — End-February 2025.

*Sources: Nepali authorities; and IMF staff estimates, projections, and program documents. Note: Fiscal year ends mid-July; current baseline forecast is as of June 10, 2024.*

### Annex I. Private Sector Credit in Nepal: Transitioning to a

### Annex I. Private Sector Credit in Nepal: Transitioning to a Sustainable Growth Path

### Background
- Private sector credit expanded significantly in recent years and has recently undergone a correction.
- Drivers of the decade-long rapid credit growth included large inflows of remittances, accommodative monetary policy, lax supervision, and pandemic-related stimulus.
- Credit-to-GDP ratio reached close to 100 percent.
- When scaled by Gross National Disposable Income (GNDI), pre-pandemic credit levels appear more in line with regional peers.
- The recent correction follows ten years of fast credit growth.

### Measuring the Credit Cycle
- The credit-to-GDP deviation from its long-term trend (credit gap) is used as the principal measure of the credit cycle.
- Methodological choices:
  - Denominator: trend nominal GDP (combining the actual GDP deflator and estimated potential real GDP).
  - Trend estimation: adjusted Hodrick-Prescott (HP) filter with parameters for business cycle frequencies and adjustments reflecting Nepal team assessments.
  - Rationale: accounts for short duration of Nepal’s credit cycles and the short span of available credit data; after 2011 average credit cycle duration estimated at only 8 quarters.
- Historical credit gap behavior:
  - Pre-pandemic cycles: credit gap averaged about 1 percentage point (pp) during boom years and -1 pp during deleveraging episodes.
  - Pre-pandemic extremes: maximum peak around 2.5 pp in FY2018/19; minimum trough close to -4 pp after the 2015 earthquake.
  - Latest post-pandemic cycle: credit gap expanded to above 10 pp at peak and contracted to approximately -5 pp recently, marking the latest cycle as an outlier.

### Assessing Drivers of Historical Credit Cycles
- Analytical angles: macroeconomic (business cycle interactions), policy (NRB regulatory changes), and market (sectoral allocation of credit).
- Macroeconomic relationships:
  - Before the pandemic (2012Q3-2020Q3): output gap tended to lead the credit gap by one quarter.
    - Cross-correlation strongest between current-period credit gap and output gap lagged by one quarter (j=1: 0.73 vs j=0: 0.46).
    - Pairwise Granger causality: reject null that output gap does not Granger cause credit gap (F-Stat 8.2957, Prob. 0.0015); do not reject null that credit gap does not Granger cause output gap (F-Stat 0.0691, Prob. 0.9334).
  - After the pandemic (2020Q4-2023Q4): credit and output gaps became more contemporaneous.
    - Cross-correlation strongest contemporaneously (j=0: 0.86).
    - Pairwise Granger causality: reject null that credit gap does not Granger cause output gap (F-Stat 5.3062, Prob. 0.0341); do not reject null that output gap does not Granger cause credit gap (F-Stat 0.1112, Prob. 0.8961).
  - Interpretation: pre-pandemic credit cycles were largely demand-driven (output leading credit); post-pandemic the relationship likely reversed with credit expansion driving domestic demand.
- Investment-to-credit ratio (ICR) evidence:
  - Rising ICR alongside credit growth and non-inflationary GDP growth signals credit allocation toward productive investment.
  - ICR increased before the 2015 earthquake and during FY2016/17-FY2018/19 in tandem with credit ratio and strong non-inflationary growth.
  - ICR had a big one-off drop in FY2015/16 but recovered quickly due to reconstruction.
  - After a contraction in FY2019/20, ICR did not recover post-pandemic; it declined despite booming credit growth in FY2020/21-FY2021/22.
  - Note: unlike past episodes where higher public investment offset some private investment decline, post-pandemic both private and public investment-to-GDP ratios have been declining.
- Policy/regulatory stance:
  - Preceding the post-pandemic boom there was broad-based regulatory easing across liquidity measures, capital requirements, and asset quality requirements.
  - Contrast: pre-pandemic credit cycles typically featured regulatory relaxations limited to one or two categories; the pandemic period saw relaxations across all categories.
  - Implication: post-pandemic boom appears primarily supply-driven due to regulatory easing, whereas pre-pandemic booms were largely demand-driven.

### Sectoral Credit Performance
- General pattern:
  - During the latest expansion, all sector-groups experienced abnormal credit ratio growth by pre-pandemic standards, and almost all contracted in the deleveraging—unlike pre-pandemic cycles.
  - Total credit median growth rates (in percentage points):
    - Expansion (pre-pandemic): 5.75
    - Deleveraging (pre-pandemic): 2.07
    - Expansion (latest): 21.24
    - Deleveraging (latest): -5.87
- Selected sector-group median growth rates of sectoral credit ratios (in percentage points):
  - G1. Agriculture: Expansion (pre-pandemic) 0.71; Deleveraging (pre-pandemic) 0.28; Expansion (latest) 3.17; Deleveraging (latest) -0.48
  - G3. Energy, Transportation, Communications, & Public Services: Expansion (pre-pandemic) 0.70; Deleveraging (pre-pandemic) 0.30; Expansion (latest) 1.63; Deleveraging (latest) 0.04
  - G8. Household Consumption: Expansion (pre-pandemic) 1.41; Deleveraging (pre-pandemic) 0.14; Expansion (latest) 6.70; Deleveraging (latest) -2.12
  - G6. Wholesale & Retail Trade: Expansion (pre-pandemic) 1.33; Deleveraging (pre-pandemic) 0.15; Expansion (latest) 4.07; Deleveraging (latest) -1.36
  - G4. Private Services: Expansion (pre-pandemic) 0.38; Deleveraging (pre-pandemic) 0.19; Expansion (latest) 1.09; Deleveraging (latest) -0.66
  - G5. Real Estate: Expansion (pre-pandemic) -0.10; Deleveraging (pre-pandemic) -0.10; Expansion (latest) 0.45; Deleveraging (latest) -0.21
- Sectoral weights and drivers:
  - FY2016/17-FY2018/19 expansion was driven by export-oriented sectors, notably:
    - G4. Private Services: weight in overall credit increased by 0.8 percentage points.
    - G3. Energy, Transportation, Communications, & Public Services: weight increased by 0.8 percentage points.
  - FY2020/21-FY2021/22 expansion was driven by consumer credit:
    - G8. Household Consumption led the latest credit boom; this sector had the least allocation during FY2016/17-FY2018/19.
  - During the latest boom, G3 and G4 saw their weights decline by 0.6 and 0.5 percentage points respectively.
- Non-performing loans (NPLs):
  - Class A banks' overall gross NPL ratio increased by about 2.7 percentage points between October 2021 and April 2024 (from 1.2 to 3.9 percent).
  - Sectoral NPL concentration and rises:
    - Wholesale & Retail: largest rise in NPL ratios and accounts for about one third of all NPLs.
    - Agriculture and Agriculture-related production: 15 percent of all NPLs.
    - Construction: 10 percent of all NPLs.
    - Consumable loans: 10 percent of all NPLs.
    - Non-food production: 8 percent of all NPLs.
    - Electricity, Gas and Water (including hydroelectric sector): saw a mild reduction in NPL ratio.

### Policy-relevant Insights and Implications
- Characterization of cycles:
  - Pre-pandemic cycles: mostly demand-driven, credit allocated broadly towards investment activities, supported robust non-inflationary growth.
  - Post-pandemic cycle: largely supply-driven, facilitated by broad-based regulatory relaxation, credit disproportionately channeled to households and non-tradable sector firms, accompanied by declining ICR and higher inflation.
- Risks of supply-driven booms:
  - Supply-driven credit booms typically produce less efficient credit allocation, poorer credit quality, more disruptive busts, and slower medium-term growth.
- Regulatory response and outlook:
  - Recent regulatory adjustments by the NRB, if sustained, can support a transition to more sustainable and pro-growth credit allocation and help prevent disruptive boom-bust cycles in the future.

*Source: Annex I. Private Sector Credit in Nepal: Transitioning to a Sustainable Growth Path (IMF staff estimates and Nepali authorities as presented in the supplied content).*

### Annex I. Table 5. Nepal: Rate of Change in NPL Ratios by Sector

### Annex I. Table 5. Nepal: Rate of Change in NPL Ratios by Sector

### Data and scope
- Quarterly data for the 10 largest Class A banks (representing about 60 percent of the Class A banking system by assets) for the period between October 2021 and January 2024, which encompasses the latest credit cycle.
- Rationale: Given the well-dispersed and competitive banking sector in Nepal, and largely similar sectoral credit exposure among Class A banks, due in part to the NRB’s directed lending requirements, the dynamics of NPL ratios for these 10 banks is broadly representative of the NPL dynamics across all Class A banks.
- Sources: Nepali authorities and IMF staff estimates.

### Sectoral rates of change in NPL ratios (in percentage points, quarter-on-quarter)
- Table key: Range:FY17─FY19 FY21─FY22 FY22─FY24
- G4. Private Services: 0.8-0.5-0.2
  - (+):Hotels; (-):Non-resid. Constr.
- G3. Energy, Transp., Comm. & Pub. Serv.: 0.8-0.6-1.6
  - (+):Electr., Heavy Constr.; (-):Hospitals, Educ.
- G7. Finance: 0.6 0.7-0.4
  - (+):MFIs; (-):Cooperatives
- G1. Agriculture: -0.1 0.9 0.8
  - (+):Agriculture; (-):Food Prod.
- G6. Wholesale Retail Trade: -0.2-0.2 0.0
  - (-):Wholesale & Retail
- G2. Non-food Production: -0.2-0.9-0.2
  - (+):Cement, Iron; (-):Textile
- G5. Real Estate: -0.5-0.3-0.2
  - (-):Real Estate
- G8. Household Consumption: -1.3 0.9-1.4
  - (-):Consumable Loan, Resid. Constr.

### Key analytical findings
- The analytical findings suggest that the nature of credit growth in Nepal changed during the pandemic:
  - Pre-pandemic credit growth was mostly demand-driven and directed broadly towards investment.
  - The latest credit boom was largely supply-driven, with ‘easy’ credit flowing disproportionately towards household consumption and less productive economic activities, so that the ratio of private investment to credit has been steadily declining.
  - Credit directed towards investment activity tends to raise potential growth and support non-inflationary potential growth. The latest credit boom was not as investment-oriented, instead characterized by unsustainable credit growth that contributed to overheating of the economy, with a subsequent deleveraging and economic slowdown.
  - The pandemic-era credit boom was preceded by a significant and broad-based relaxation of financial regulation, unlike the pre-pandemic credit cycles.
  - Conclusion: While superficially there appears to have been more than a decade of too-fast credit growth in Nepal, a closer analysis suggests that only the recent post-pandemic credit cycle was truly excessive.
- Sectoral analysis consistency with literature:
  - Supply-driven credit booms are disproportionately allocated to non-tradable sectors and are typically more fragile.
  - In the latest credit boom in Nepal, the primary beneficiaries of 'easy’ credit conditions were mainly the non-tradable sectors.
  - The share of credit allocated to these sectors was gradually declining before the pandemic—a period which was generally characterized by increasing investment-to -credit ratio and robust non-inflationary economic growth—suggesting pre-pandemic credit to non-tradable sectors was less influential in boosting potential growth.
  - Those sectors have recently witnessed a greater increase in NPLs.
  - When considered alongside the persistent decline in the investment ratio after the pandemic and the recent economic slowdown, these observations reinforce the empirical literature's view that rapid credit expansions to non-tradable sectors often result in slower GDP growth and a higher likelihood of financial distress.

### Policy implications and recommendations
- Recent regulatory adjustments pursued by the NRB, and the government's reform agenda supported by the ECF program, can support the transition to more sustainable and pro-growth credit allocation and should continue.
- Specific measures highlighted:
  - Tightening of asset classification and lending practices (SR ¶14) are timely and crucial measures.
  - Efforts to restore the health of bank balance sheets and enhance the quality of bank lending (including the upcoming loan portfolio review) are essential despite involving some necessary adjustments.
  - These efforts can help steer lending towards more productive sectors and help avoid damaging credit boom-bust cycles in the future.
  - The government's focus on increasing investment, particularly in infrastructure and hydropower, supported by larger and more efficient capital expenditure, will help bolster long-term economic growth.
  - Continued structural reforms aimed at enhancing overall productivity, while supporting the most vulnerable, are well-aligned with the goals of the ECF program.

*Source: Nepali authorities and IMF staff estimates.*

### Annex IV. Addressing Difficulties in SACCOs

### Annex IV. Addressing Difficulties in SACCOs

### Background
- Nepal has around 32,000 cooperatives registered, including more than 14,000 savings and credit cooperatives (SACCOs) and around 10,000 non-financial cooperatives that also provide financial services.  
- As of June 2023, SACCOs hold NPR 478 billion of savings deposits and NPR 426 billion in assets.  
- SACCOs are regulated based on geographical scope (federal, provincial, local), resulting in up to a maximum of 761 different agencies involved in regulation.  
- If a SACCO is declared problematic, the relevant regulator appoints a Problematic Cooperative Asset Management Committee (PCAMC). Currently, 1 federal and 1 provincial PCAMC are in place.  
- Since mid-2023, pressures have increased due to large data gaps, weak governance, unsound credit and liquidity risk management, and lack of effective licensing, regulation, monitoring, and supervision, leading to multiple SACCO failures and closures.  
- Authorities have suspended registration of new SACCOs and in the FY2024/25 budget announced reforms including establishment of a new supervisory regulatory agency and repayment of depositors of failed SACCOs.

### Immediate steps (e.g., within 6 months)
- Suspend registering new SACCOs  
  - Rationale: current registration does not provide the same scrutiny as licensing and adequate supervision is not guaranteed. Authorities have already taken this step.  
- Address data gaps  
  - Explore contagion channels to systematically important institutions and sectors using data (including exposures) reported by Class A-D institutions.  
  - Use other data sources about cooperatives, including data in the credit bureau and umbrella organizations (e.g., NEFSCUN), to assess size and magnitude of the problem.  
  - Consider ad hoc reporting of core supervisory data; targeted data requests can help identify and triage problematic SACCOs.  
- Design a strategy to clean-up SACCOs  
  - Determine short-term approaches to problematic institutions based on size and nature of problems.  
  - Resolution options should follow the existing legal framework and could focus on liquidation combined with repayment of savings of failed SACCOs, transfer of assets and liabilities of a failed SACCO to a healthy SACCO, or continuation after restructuring.  
  - Establish a pragmatic and workable institutional structure: policy development at the federal level; implementation at sub-national level coordinated by the federal level through strengthened coordination mechanisms. All authorities involved must be adequately resourced, exchange information, and coordinate actions.  
  - Urgently operationalize the SACCO resolution regime in the Cooperatives Act (extend its application to all SACCOs if necessary) and support sub-national authorities to establish and strengthen PCAMCs.  
- Triage and resolve problematic SACCOs  
  - Following data collection, triage SACCOs based on condition per the strategy.  
  - Triaging requires information to identify problematic SACCOs and assess their financial situation.

### Near-term steps (e.g., within 1 year)
- Tighten and enforce existing regulatory requirements  
  - Raise the bar for SACCOs while customizing requirements to size, nature of business, and realistic supervisory capacity.  
  - Potential areas to tighten: capitalization, liquidity, loan concentration, governance.  
  - Require regular reporting; give SACCOs a period to meet requirements, with close monitoring of compliance. Non-compliant SACCOs may consolidate or wind down.  
- Implement new regulatory framework for SACCOs, including a second-tier institution  
  - Improve regulatory framework and build regulatory, supervisory, reporting and enforcement structures with sufficient supervisory capacity.  
  - Regulatory mandate needs to be proportional to size and complexity of SACCOs and could cover licensing, capital, liquidity, governance, human resources and systems, external audits, and regular reporting.  
  - For a multi-tier supervisory model to be effective, a central supervisory authority (such as a second-tier regulatory agency) should ensure system-level stability and may conduct direct supervision of the largest institutions or umbrella institutions, with sufficient enforcement powers.  
  - Once supervisory architecture decisions are made, establish institution(s) with clear legal mandate, sufficient staffing and funding; the new architecture will also be responsible for licensing (see medium-term steps).

### Medium-term steps (e.g., 1-2 years)
- Start licensing of SACCOs  
  - Implement licensing for both existing SACCOs and new entities to reflect new regulatory requirements and prepare cooperatives and supervisors for the new supervisory regime.  
  - Licensing should include a mechanism to verify compliance and a process to treat major non-compliance (which could result in withdrawal/suspension of the license).  
- Expand SACCO institutional architecture  
  - After clean-up and licensing, expand institutional architecture: Cooperatives Act includes creation of a debt information center, credit tribunal and a savings and guarantee fund for SACCOs.  
  - Align new institutions with existing structures, for example: set up the debt information center within the Credit Information Bureau and model the savings and guarantee fund on the Nepali Deposit Insurance System (DCGF).

*Source: Annex IV. Addressing Difficulties in SACCOs (extracted from the provided PDF content).*

### 9. We believe that the commitments outlined in the MEFP are adequate to make progress with the

### 1nplea2024001-print-pdf - 9. We believe that the commitments outlined in the MEFP are adequate to make progress with the

### Program commitment, request, and consultations
- Government and Nepal Rastra Bank (NRB) reaffirm commitment to the ECF-supported program and to consult the IMF in advance of any substantive revisions to MEFP policies and reforms.
- Appreciation expressed for IMF technical assistance and capacity development since ECF approval.
- Request to make SDR 31.4 million available for the fourth review under the ECF.
- Explicit commitments:
  - Do not intend to introduce measures or policies that could generate balance-of-payments difficulties or which are inconsistent with Article VIII of the IMF’s Articles of Agreement.
  - Do not intend to accumulate external or domestic arrears.
  - Consent to publication of the letter, attached MEFP and TMU, the staff report and other ECF-related documents on the IMF’s website.

*Signed by Mr. Maha Prasad Adhikari, Governor, Nepal Rastra Bank; and Hon. Barsha Man Pun, Finance Minister.*

### Background and program progress
- Remain fully committed to the ECF arrangement approved in January 2022.
- Fourth review quantitative performance criteria and continuous performance criteria were met.
- Structural benchmark (SB) progress:
  - Out of five SBs, three were completed (one with delay).
  - Two SBs not completed and proposed to be reset for future reviews.
- Factors shaping recent policy adjustments:
  - Liquidity, credit and macroprudential easing during the pandemic aided recovery but contributed to imbalances.
  - Policies implemented to rein in credit surge, high inflation, and restore external stability included monetary prudential tightening and fiscal measures to preserve debt sustainability.
  - Subsequent slowdown and financial sector stress, particularly in the non-banking sector, required targeted interventions.

### Recent macroeconomic developments and outlook
- Growth and sectoral evolution:
  - Real GDP growth slowed to 2.0 percent in FY2022/23.
  - Growth rebound to 3-4 percent expected in FY2023/24, supported by a good harvest, strong recovery in tourism, and additional hydroelectricity—still below potential.
- Inflation and external sector:
  - Inflation declined to 4.4 percent in mid-May 2024, within an estimated ceiling of 6.5 percent for FY2023/24.
  - Current account set to reach a surplus of 3.2 percent of GDP in FY2023/24.
  - Reserves remain on an increasing trend and comfortably above adequacy levels.
- FY2024/25 outlook:
  - Growth recovery expected to continue supported by stronger domestic demand, cautiously accommodative monetary policy, increased execution of capital expenditure, tourism, recovery in imports, and additional hydropower capacity.
  - Monetary policy will adjust as needed to keep inflation within the policy target ceiling of 5.5 percent.
  - Current account expected to fall moderately in FY2024/25 with reserves remaining adequate, supported by robust remittance inflows.
- Downside risks identified:
  - Need to improve public expenditure execution for growth-enhancing capital projects.
  - Financial sector risks: further rise in bank NPLs and more cooperative failures.
  - Limited progress on AML/CFT reforms ahead of FATF review could challenge access to the global financial system.
  - Continued budget under-execution risks fiscal dynamics.
  - External shocks: sharp slowdowns in partner economies or higher global commodity prices (fuel, food) with pronounced inflation, food security and poverty impacts.
  - Vulnerability to natural disasters and weather variability affecting food production and poverty reduction.
- Policy stance: intend to take forward-looking, data-driven monetary and fiscal approaches and stand ready to adjust the policy stance.

### Economic and financial policies — Fiscal policy
- Fiscal outcomes and targets:
  - Tax revenue-to-GDP ratio has not rebounded to the pre-pandemic range of 18-19 percent of GDP despite FY2023/24 tax measures.
  - Overall fiscal deficit excluding revenue sharing with local governments expected to decline to 2.8 percent of GDP.
  - Negative federal government cash balance expected to remain high relative to historical trend at end of FY2023/24 due to tight fiscal conditions and domestic borrowing limit.
- FY2024/25 budget orientation:
  - Broadly consistent with program target to stabilize public debt at a moderate level.
  - Measures include: introducing a green tax on petroleum products; raising taxes on vehicles; increasing excise duties on alcohol, beer, and tobacco; improving tax compliance (aligned with Domestic Revenue Mobilization Strategy).
  - Revenue gains partially offset by planned reduction or elimination of duties on some raw materials and intermediate goods.
  - Actions to curtail spending duplication with subnational governments, expand targeted social spending, and reverse low execution of capital expenditure.
  - Aim to increase absorption of external concessional financing, in particular project loans, to support growth while maintaining debt stability.

### Revenue mobilization
- Approved comprehensive Domestic Revenue Mobilization Strategy (DRMS) (end-April 2024 SB) covering tax policy, law and revenue administration reforms.
- Reforms will draw on TADAT diagnostic (late 2022) and IMF TA on simplifying tax policy while broadening the base.
- Plans to harmonize procedures across taxes and accelerate digitalization, including integrated IT systems for Inland Revenue Division responsibilities (registration, processing, payment).
- Tax transparency:
  - Detailed assessment of costs of non-customs-related tax exemptions (VAT, CIT, PIT) conducted beyond September 2023 publication.
  - Commitment to continue estimating cost of exemptions at Department of Customs and publish exemptions and costs as inputs to a comprehensive tax expenditure report (end-January 2025 SB).
  - IMF TA team scheduled visit in September 2024 to support reform and capacity building.
  - Draft tax expenditure report to be shared with IMF by end-November 2024 for feedback.

### Expenditure reforms and public investment management
- Commitment to enhance efficiency of capital spending and boost public investment share in FY2024/25 budget.
- Actions and timelines:
  - NPC approved an action plan to improve public investment efficiency and strengthen climate resilience (end-April 2024 SB).
  - Cabinet approved the 16th National Development Plan reflecting PIMA Action Plan findings.
  - NPC to approve reformulated National Project Bank Operational Procedures and revised Unified Directives related to project development (new, end-March 2025 SB).
  - Draft procedures and directives to be shared with IMF by end-December 2024; approval by end-March 2025.
  - Update and link the National Project Bank Management Information System (NPBMIS) with Line Ministries Budget Information System (LMBIS) by end-July 2025; subsequent linking of Provincial Project Bank MIS with NPBMIS.
  - Budget to include only major public investment projects selected from Project Bank and appraised using revised procedures; guarantee all multi-year future financing commitments starting FY2025/26.
- Cash flow management:
  - Continue strengthening cash flow management with IMF TA envisaged for June 2024.
  - Cabinet approval sought for Guidelines on Cash Flow Management issued by Ministry of Finance last year.
  - Cash flow forecasts to be shared among FCGO, PDMO and NRB on a regular basis (end-September 2023 SB, met).
- Fiscal risk management:
  - Fiscal risk registry prepared and currently implemented (end-August 2023 SB, met); will be expanded to include subnational governments and PPPs.
  - Publish fiscal risk section in the Fiscal Policy Statement of FY2024/25 budget; prepare and publish a comprehensive fiscal risk statement with FY2025/26 budget (end-August 2025 SB).
  - Supported by IMF TA, government will review subnational entities to identify largest fiscal risks.
- Public enterprises and extra-budgetary oversight:
  - Require all majority- and wholly-owned PEs to publish FY2022/23 annual financial statements by end-August 2024 (end-August 2024 SB).
  - Four priority nonfinancial PEs (Nepal Electricity Authority, Nepal Oil Corporation, Nepal Airlines Corporation (NAC) and Nepal Telecom) to have FY2022/23 financial statements audited by August 2024 (end-August 2024 SB); three have completed the audit.
  - Engage NAC and Ministry of Culture, Tourism and Civil Aviation to ensure NAC provides financial statements to OAG by end-June 2024; prioritize audits of FY2023/24 financial statements of other PEs by mid-FY2024/25.
  - FCGO included 88 extra budgetary units at the Federation level and 5 EBUs at the provincial level in FY2022/23 annual financial statements; intend to include all EBUs in NPSAS-based financial statements for FY2023/24 (end-January 2025 SB).
  - FCGO will document commitments from line ministries based on contract information to help monitor arrears and endeavor to address any potential arrears.

### Social spending and safety nets
- Commitment to fully execute allocated budget for child grants in FY2023/24 (Indicative Target) despite transitional disbursement issues.
- Plan to expand child grant coverage to all 77 districts as resources become available.
- Expanded scholarship program now includes students from grades 6 to 12 from marginalized and underprivileged communities.
- Continue support for food security and poverty reduction through child grants, mid-day meal program, and expanded Prime Minister’s Employment Program.
- Development of National Social Registry (NSR), including national identification cards, to improve identification of vulnerable households and targeting of social transfers.

### Monetary and exchange rate policy
- Monetary stance: cautiously accommodative in an environment of ample liquidity.
  - Interbank rate maintained around the bottom of the interest rate corridor (IRC) this fiscal year, effectively a loosening of about 400 basis points since July 2023.
  - Lending rates have come down by almost 200 basis points since July 2023.
  - Limited credit growth amid deleveraging following the post-pandemic credit boom.
- Policy objectives: data-dependent stance to achieve primary target of price stability, while maintaining banking and financial sector stability and external sector stability.

_This summary is based on the attached Memorandum of Economic and Financial Policies and accompanying text._

### 17.      We commit to implementing the interest rate corridor (IRC) as designed, with the

### We commit to implementing the interest rate corridor (IRC) as designed, with the midpoint as the target rate.

### Monetary policy and interest rate corridor (IRC)
- Commit to implementing the IRC as designed, with the midpoint as the target rate.
- Rationale: Development of the interbank market depends on predictable, well-communicated monetary policy; maintaining the interbank rate at the midpoint is essential for clarity and credibility.
- Observation: the interbank rate has remained at or below the bottom of the corridor for most of this fiscal year.
- Response actions:
  - Endeavor to move the IRC or intervene as necessary to secure the interbank rate at the mid-point, in line with Fund TA recommendations.
  - Monetary policy will remain nimble, including to appropriately raise the target rate should inflation pressures reappear.
  - To absorb liquidity at the bottom of the IRC, the NRB introduced the Deposit Collection Facility in February 2024.
  - Continue to develop and refine the monetary policy toolkit to improve IRC functioning in line with IMF TA recommendations.
- Operational change: Except for improving financial inclusion in remote areas, balances of local governments in the banking system are no longer counted as deposits.

### Banking sector metrics, pressures, and immediate supervisory focus
- Key statistics and developments:
  - Aggregate gross NPL levels of the banking sector rose to approximately 4.0 percent in April 2024, a 0.6 percentage point increase over the previous year.
  - Aggregated bank capital ratios have decreased by 0.5 percent since January 2023 to 9.6 percent.
  - Loan loss provisioning coverage for the sector is 70 percent in April 2024.
- Context: credit surge and reforms to asset classification and Working Capital Loan (WCL) framework have led banks to adjust lending practices and reclassify loans.
- Consequences:
  - Bank profitability has fallen amid weak economic growth and declining bank income.
  - Increasing difficulties in NPL management, resulting in increases in non-bank assets and accrued interest.
- Supervisory stance:
  - Phase-out of forbearance on loan restructuring/rescheduling; continued prudential monitoring to ensure appropriate loan classification, restructuring, provisioning, and capitalization.

### Loan portfolio review and remediation plans
- Planned exercise:
  - Conduct a loan portfolio review of the 10 largest banks to ensure compliance with the new regulatory framework, with attention to evergreening, group borrowing, and concentration risks.
- Timeline and procurement status:
  - Terms of Reference finalized in January.
  - Request for Proposal (RFP) issued to five short-listed parties in May 2024.
  - Procurement delay prevented launching by end-April 2024; propose resetting the benchmark to end-August (end-April 2024 SB, reset to end-August 2024).
  - To expedite launch, groundwork will start by preparing a document on priorities and information resources for the selected consultant.
  - Complete the exercise by end-February 2025 (end-December 2024 SB, reset to end-February 2025).
  - Develop a plan to deal with the review’s findings by end-February 2025 (end-February 2025 SB).
- Remedial requirement: any bank with capital shortfalls will be required to submit time bound capital management plans to return to full regulatory compliance.

### Strengthening regulation, supervision, and macroprudential toolkit
- Recent and planned reforms:
  - Finalized the Supervisory Information System—including the on-site module for all banks (end-April 2024 SB, met).
  - Implemented a manual for onsite and offsite supervision.
  - Introduced the countercyclical capital buffer at 0.5 percentage points for this fiscal year.
  - Developing/enhancing credit risk modelling and assessment capabilities with Fund technical assistance ahead of IFRS-9 implementation in FY2024/25.
  - Aim to finalize policies for Liquidity Coverage Ratio implementation and start an implementation pilot in FY2024/25, while consulting with banks.
  - Stand ready to use other macro-prudential tools to mitigate buildup of financial vulnerabilities.
- Macroprudential measures currently implemented by NRB:
  - 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 to 70 percent).
  - Debt-to-equity ratio (4:1).
  - Loan to value ratios (between 50 and 70 percent).
  - Sectoral limit (40 percent of total outstanding loans).
- Priority: improve the bank resolution framework in line with the 2023 Financial Sector Stability Report (FSSR).
- Other supervisory actions:
  - Streamline prompt corrective action framework with a clear escalation process across states of distress.
  - NRB remedial actions for capital issues include suspension of dividend payments.
  - Issue new policy measures to allow banks to raise additional capital and use early intervention measures where necessary.

### SACCOs, financial inclusion, and structural sector reforms
- SACCOs actions and reforms:
  - Working to tackle problems in the SACCOs to avoid contagion and spillovers to the banking sector; registration of new SACCOs has been suspended.
  - FY2024/25 budget includes measures to improve regulatory framework, establish a regulatory and supervisory agency, facilitate consolidation of SACCOs, and safeguard SACCO assets, operators and depositors using available collateral.
  - Recognize need to reinforce coordination and information exchange between all SACCO regulators.
  - Support for subnational regulators to set up Problematic Cooperatives Management Committees may be needed.
  - Incorporating SACCO sector reforms in the 2nd Financial Sector Development strategy and devising a strategy to deal with problematic SACCOs, including creation of a regulatory and supervisory agency.

### Governance, NRB autonomy, and safeguards
- Audit and legal reforms:
  - OAG conducted audit of NRB’s FY2021/22 financial statements with auditors with international central bank auditing experience.
  - Request to Auditor General to conduct FY2023/24 audit with experts with international experience in auditing and central bank auditing (end-July 2024 SB).
  - Drafting amendments to the NRB Act to implement recommendations of the 2021 Safeguards Assessment (SGA) to strengthen NRB autonomy and governance; requires broad consensus and substantive technical/legal discussions, prompting a reset of the SB.
  - NRB to share a revised version of amendments with the Ministry of Finance by end-June; Ministry to complete a draft by mid-July and submit to Cabinet by end-July and to Parliament by end-September 2024 (end-April 2024 SB, not met and proposed to be reset to end-September 2024).

### Safeguards Assessment (SGA) progress and capacity building
- SGA implementation status:
  - Completed seven additional sub-recommendations since February 2024, bringing the total to about 2/3 of sub-recommendations completed.
  - Target to complete the following SGA recommendations by mid-August 2024:
    1) Reporting to the Audit Committee based on reporting templates proposed by Fund TA in 2018 and 2019.
    2) Adopting a medium-term plan to strengthen staff capacity, particularly in internal audit, financial reporting, and foreign reserves management.
    3) Completing certification of the Chief Information Security Officer (CISO) or otherwise appointing a qualified CISO in the Information Security Unit.
  - Continue strengthening foreign exchange reserves management through better segregation of responsibilities, stronger accounting, and valuation criteria, drawing on recent IMF TA.
- Status metric: 5 out of 16 recommendations have been fully implemented and the others are in progress.

### AML/CFT reforms
- Urgency and timeline:
  - Strengthening of AML/CFT framework is urgent as the International Co-operation Review Group observation period related to APG mutual evaluation ends soon.
  - Aim to avoid FATF listing for strategic AML/CFT deficiencies.
  - Enacted “Amendments to Some Laws relating to AML and Business Promotion Act” to align Nepal’s AML/CFT legal framework with international standards (end-July 2024 SB).
  - Expect amendments—including secondary regulations—to improve technical compliance with FATF standards by the end of the observation period in October 2024.
- Commitments:
  - Implement remaining reforms in the APG action plan via the new AML/CFT National strategic plan with Fund and development partner TA.
  - Reforms include changing relevant regulations, improving capacity, understanding ML/TF risks, strengthening supervision and enforcement.

### Structural reforms to boost growth and climate resilience
- Commitments to address structural barriers and enhance growth:
  - Reduce cost of doing business via simplifying regulatory provisions and gradually improving foreign investment climate.
  - Strengthen governance and anticorruption institutions; continue digitalizing government services.
  - Improve inter-relationship between tiers of government in advancing fiscal federalism.
  - Enhance transparency, accountability, and effectiveness of public administration.
- Climate and resilience priorities guided by NDC and NAP:
  - Advance climate smart agriculture (CSA) practices.
  - Enhance sustainable forest management (SFM).
  - Strengthen social protection systems.
  - Implement disaster risk financing (DRF) mechanisms and instruments.
- Development plan priorities (16th Development Plan):
  1) Increasing productivity in agriculture, industry and trade-related services (IT, tourism, and hydropower).
  2) Supporting job creation.
  3) Strengthening social inclusion and integration programs to reduce inequality and support labor mobility.

### Risks, contingencies, and crisis readiness
- Risk assessment and policy flexibility:
  - Downside risks and global uncertainty remain; stand ready to adjust policies as needed.
  - Effectiveness of monetary policy constrained by credit market disruptions.
  - Prudent fiscal management in FY2023/24 provides more fiscal space should growth fail to rebound and revenues decline, while remaining within ECF program guardrails.
  - Any expenditure compression should prioritize protecting critical capital and social spending.
  - A major commodity price shock could require monetary policy tightening to maintain external stability and keep inflation in check.
- External buffers and support:
  - Foreign exchange reserve buffers are currently adequate to cushion temporary shocks.
  - If a shock is too large to be offset by buffers and policy adjustments, the government will seek assistance from development partners.
  - Ability to mobilize additional resources is aided by low risk of debt distress, strong repayment track record, and ECF-supported program commitments.
- Financial sector contingency:
  - NRB has been improving its tools and remains vigilant to prevent potential banking problems.
  - In event of bank stress, NRB stands ready to provide systemic liquidity support while triaging deeper solvency problems.
  - Policies will be adopted to prevent spillovers from SACCO difficulties.

### Financing and program monitoring
- Financing plan:
  - Continue to mobilize resources from international development partners to support the reform program.
  - Remaining financing needs for the program are 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.
- Coordination:
  - Continue working with development partners, including the IMF, the World Bank and the Asian Development Bank, to implement the outlined reforms.

*Source: Excerpt from IMF staff report content unit 1nplea2024001-print-pdf.*

### 30.      The program will be closely monitored through quantitative performance criteria,

### The program will be closely monitored through quantitative performance criteria,

### Monitoring framework and review schedule
- The program will be monitored through quantitative performance criteria, indicative targets, and structural benchmarks as listed in Tables 1 and 2. The Technical Memorandum of Understanding (TMU) describes definitions and data provision requirements.
- The ECF program is monitored on a semi-annual basis by the IMF Executive Board.
- The authorities request that an amount of SDR 31.4 million is made available for the fourth review.
- Reviews and associated test dates:
  - Fifth review scheduled on or after November 1, 2024; test date: July 15, 2024.
  - Sixth review scheduled on or after May 1, 2025; test date: January 13, 2025.
  - Seventh review scheduled on or after November 1, 2025; test date: July 15, 2025.
- The government undertakes to adopt, in consultation with IMF staff, any new financial or structural measures necessary for program success.

### Structural benchmarks (selected measures, target dates, and status proposals)
- Cross-Cutting Institutional Reforms to Enhance Fiscal Transparency and Governance and Reduce Vulnerability to Corruption:
  - The FCGO reports the consolidated financial information of all operational funds in annual financial statements, starting with FY2021/22 — Target: End-January 2025.
  - The MOF submits to Parliament amendments to modernize the NRB Law, addressing key recommendations of the 2021 Safeguards Assessments Report — Original Target: End-April 2024; Status: Not Met; Proposal: Reset to end-September 2024.
  - An audit of the FY2023/24 financial statement of the NRB is conducted involving the service of experts with international experience in auditing and central bank auditing — Target: End-July 2024; Status: Modified.
  - Report that the Amendments to Some Laws Relating to AML and Business Promotion bill has been enacted in line with Financial Action Task Force AML/CFT international standards — Target: End-July 2024.
- Revenue Mobilization:
  - MOF approval of a revenue mobilization strategy covering tax policy, law, and revenue administration reforms — Original Target: End-April 2024; Status: Not Met, Implemented June 2024.
  - The MOF publishes a comprehensive report on tax expenditures — Target: End-January 2025.
- Fiscal Sustainability and Fiscal Risk Management:
  - A comprehensive fiscal risk statement is published by the MOF with the FY2025/26 Budget — Target: End-August 2025.
  - All majority- and wholly-owned PEs will publish their FY2022/23 annual financial statements — Target: End-August 2024.
  - The four priority nonfinancial PEs (Nepal Electricity Authority, Nepal Oil Corporation, Nepal Airlines Corporation and Nepal Telecom) will have their FY2022/23 financial statements audited — Target: End-August 2024.
- Equitable and Sustainable Growth:
  - National Planning Commission approves an action plan to improve the efficiency of public investment spending and strengthen climate resilience, drawing on recommendations of a Public Investment Management Assessment (PIMA) — Target: End-April 2024; Status: Met.
  - NPC approval of the revised National Project Bank Operational Procedures and the Unified Directives related to project development, prioritization, and selection — Target: End-March 2025; Status: New.
- Financial Sector Regulation & Supervision:
  - The NRB completes implementation of the onsite module of the SIS among class A banks — Original Target: End-April 2024; Status: Met.
  - Launch for 10 largest Banks in-depth on-site inspections assisted by independent international third-party auditors — Original Target: End-April 2024; Status: Not Met; Proposal: Reset to end-August 2024.
  - NRB completes in-depth on-site inspections for the 10 largest Banks, assisted by independent international third-party auditors — Original Target: End-December 2024; Proposal: Reset to end-February 2025.
  - NRB finalizes a roadmap outlining its approach to the outcome of the in-depth on-site inspections — Target: End-February 2025.

### Quantitative performance criteria and indicative targets (selected figures from Table 2)
- Quantitative performance criteria under the ECF-supported program (Primary deficit of the federal government, ceiling; in NPR million):
  - FY2023/24 (15-Jul-24 test): Program target 435,959; Adjusted target 440,278; Outturn 178,827; Status: met.
  - FY2023/24 (13-Jan-25 test): Program target 315,628; Adjusted target 233,270; Outturn 256,943.
- Stock of NRB's net international reserves (floor; in U.S. dollars million):
  - FY2023/24 (15-Jul-24 test): Program target 8,038; Adjusted target 6,998; Outturn 10,473; Status: met.
  - FY2023/24 (13-Jan-25 test): Program target 9,076; Adjusted target 9,014; Outturn 12,144; Status: met.
  - FY2024/25 (15-Jul-25 test): Program targets listed: 9,076; 9,649; 9,845.
- Accumulation of external payments arrears (ceiling): 0/0/0; Status: met (continuous).
- Indicative targets (selected):
  - Primary deficit of the federal government (ceiling; in NPR million): 256,523; 355,213; 315,070; Status: met.
  - Federal government spending on child allowance (floor; in NPR million): Initial figures 6,987; 6,987; 6,763; Status: not met; subsequent periods 3,092; 3,092; 1,674; Status: not met.
  - Indicative target: floor on tax revenue of the federal government: 845,938; 392,743; 902,288.
- Memorandum items (selected):
  - Budget support from development partners (in U.S. dollars million) cumulative:
    - For testing dates cumulative figures shown: 330; 171; 162; 100; 325; 334; 493 (table entries present).
  - Revenues of the budgetary central government under the program (in NPR million): 968,166; 838,029; 341,044; 438,939 (table entries present).
  - Revenue targets of the budgetary central government (in NPR million): 1,066,000; ..; 563,983; 1,248,620; ..; 1,125,209.
  - Primary deficit adjustor for revenue (in NPR million): ..; 109,170; ..; 0; ...... (table entries present).
  - Ceiling of primary deficit adjustor for revenue shortfalls (in NPR million): 109,170; ..; 61,009; ...... (table entries present).
  - Foreign-financed project loan disbursements (in NPR million): 104,207; 93,727; 13,977; 18,295; 83,832; 12,501; 92,620.
  - Primary deficit adjustor for foreign-financed project loan disbursements (in NPR million): ..; -10,480; ..; 4,319; ...... (table entries present).

### TMU: Program exchange rates, valuation, and NIR definition
- Program exchange rates and valuation:
  - All USD assets/liabilities converted into NPR at a program exchange rate of NPR 133.3 per one USD (exchange rate on May 20, 2024).
  - Gold holdings valued at USD 2333.6 per troy ounce (price in April 2024 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 May 20, 2024 exchange rates reported in Table 1.
- Table 1: Nepal: Program Exchange Rates (selected entries)
  - U.S. dollars / Nepali rupee: 0.007
  - U.S. dollars / U.K. pound: 1.270
  - U.S. dollars / Indian rupee: 0.012
  - U.S. dollars / Chinese yuan: 0.138
  - U.S. dollars / Euro: 1.086
  - U.S. dollars / SDR: 1.325
  - (Full table of currencies and program exchange rates is specified in the TMU.)
- Net international reserves (NIR) of NRB:
  - NIR defined as reserve assets minus reserve related liabilities of NRB expressed in U.S. dollars.
  - Reserve assets defined per BPM6 and include monetary gold, SDRs, Nepal’s reserve position in the IMF, foreign currency cash, and readily available deposits abroad. Exclusions include pledged/collateralized assets, claims on residents, precious metals other than monetary gold, illiquid assets, and claims arising from derivatives.
  - Reserve related liabilities include foreign exchange liabilities of 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.
  - All foreign-currency related assets and liabilities measured for program NIR will be converted into USD at the exchange rates specified in paragraph 1, Table 1.
- NIR floor adjustors:
  - Program NIR targets include an adjustor for budget support from development partners.
  - If actual budget support disbursements are below program projections, the NIR floor will be adjusted downward by the difference, subject to a cap.
  - A downward adjustment to the NIR floor will be capped at USD 556 million.

### Budget support projections under the program
- Table 2. Nepal: Budget Support from Development Partners Projected under the Program (cumulative over the period from January 15, 2024 to July 15, 2025):
  - January 13, 2025: 334 (USD million)
  - July 15, 2025: 493 (USD million)

### Primary deficit: definition, coverage, and adjustors
- Coverage:
  - The budgetary central government for the program consists of all entities listed in the Administrative Expenditure Estimate table of the budget (Table 3 lists institutions included).
- Definition and computation:
  - Primary deficit of the budgetary central government = primary expenditures minus revenues.
  - Primary expenditures include capital expenditures and recurrent expenditures except interest payments. Financing expenditures (amortization of domestic and external borrowing, loan and share investment in public enterprises and other enterprises, and foreign share investments) are excluded.
  - Revenues are those to be deposited in the Federal Treasury and include all taxes and non-tax revenue as defined in the budget. Revenue sharing for province and local levels is excluded. Other receipts are excluded.
  - Revenues and primary expenditures should be recognized on a cash basis.
  - The Financial Comptroller General Office monthly reports will be used as the basis for program monitoring.
- Adjustors:
  - Program targets for the primary deficit include adjustors for the level of revenue collection and for foreign-financed project loan disbursements on concessional terms.
  - Upward adjustment to the primary deficit ceiling for revenue shortfalls is capped at NPR 61,009 million for the January 14, 2024 test date. The adjustor will be phased out starting at the July 15, 2024 test date.
  - Foreign-financed project loan disbursements are defined as the difference between total external financing and budget support from development partners.
  - The revenue adjustor will be phased out starting at the July 15, 2024 test date.

*Source: Nepal — IMF staff and authorities Technical Memorandum of Understanding and Memorandum of Economic and Financial Policies (selected tables and text).*

### 11.      Targets for the primary deficit of the budgetary central government are set as a

### Targets for the primary deficit of the budgetary central government

### Primary deficit targets and revenue adjustors
- Targets for the primary deficit are set as a ceiling and for cumulative flows from the end of the previous fiscal year.
- Adjustors for revenue collection (phased out starting with the July 15, 2024, test date):
  - Adjustor for revenue shortfalls:
    - If revenue outturn is below the program projection, the primary deficit ceiling will be adjusted upward by the difference between the revenue outturn and the level of revenues projected under the program.
    - The upward adjustment to the ceiling is capped at NPR 61,009 million for January 15, 2024.
  - Adjustor for revenue windfalls:
    - If revenue outturn is above the program projection but below the MOF revenue collection targets, there is no adjustment to the primary deficit target (expenditure could be higher by the equivalent amount of the revenue overperformance, keeping the primary deficit target unchanged).
    - If revenue outturn exceeds the MOF revenue collection targets, the primary deficit ceiling will be adjusted downward by the difference between the revenue outturn and the MOF revenue collection target.

### Adjustors for foreign-financed project loan disbursements on concessional terms
- Adjustor for higher than projected disbursements:
  - If actual disbursements exceed program projections, the primary deficit ceiling will be adjusted upward by the difference between actual and projected disbursements.
  - The upward adjustment to the ceiling is capped at the difference between the budget amount and the projected level of disbursement for the indicative target for the 3rd review. This cap does not apply for the quantitative performance criteria for the 4th and all subsequent reviews.
  - Purpose: the program does not constrain foreign-financed project loan disbursements on concessional terms.
- Adjustor for lower than projected disbursements:
  - If actual disbursements are below program projections, the primary deficit ceiling will be adjusted downward by the difference between actual and projected disbursements.
  - Purpose: align project spending with actual disbursement of foreign-financed project loans on concessional terms.
- Projected foreign-financed project loan disbursements (Table 4):
  - July 15, 2024: 83,832 (Million NPR)
  - January 13, 2025: 12,501 (Million NPR)
  - July 15, 2025: 92,620 (Million NPR)

### Indicative social spending target (child grant)
- Indicative target focuses on child grant spending because:
  - The child grant reaches vulnerable households, is implemented by the federal government, and is monitorable in a timely way.
  - Health and education spending are being devolved to local and provincial governments and are not fully under federal control.
- Indicative targets on the child grant include activity codes 7.1.1.10 (dalit children), 7.1.1.41 (areas designated children), and 7.1.1.43 (areas designated children).
- Targets are set as a floor for cumulative flows from the end of the previous fiscal year; spending is recognized on a cash basis and recorded when cash is paid.

### Indicative target on tax revenues of the federal government (starting July 15, 2024 test date)
- Defined as tax revenue of the federal government, including tax revenues of the budgetary central government to be deposited in the Federal Treasury.
- Exclusions: Non-tax revenue, revenue sharing for provinces and local levels, and other receipts.
- Import-related tax revenue includes import-related customs, VAT, and excise duty.
- Monthly data from the MOF will be used as the basis for program monitoring.
- Indicative targets are set as a floor and for cumulative flows from the end of the previous fiscal year.

### Continuous performance criteria on external payment arrears and debt definition
- Continuous quantitative performance criterion: prohibition on the non-accumulation of new external payments arrears on external debt contracted or guaranteed by the budgetary central government or NRB.
  - External payment arrears include total external debt service obligations (principal and interest), penalties, and interest charges not paid at maturity and falling due to nonresidents after approval of the arrangement.
  - Exclusions: (i) external arrears subject to debt rescheduling agreements or negotiations; and/or (ii) disputed external debt service obligations.
- Debt definition (per paragraph 8 of the Guidelines on Public Debt Conditionality):
  - Debt is a current, not contingent, liability created under a contractual arrangement requiring payments of assets or services according to a specific schedule.
  - Primary forms include: (i) loans (including deposits, bonds, debentures, commercial loans, buyers’ credits, repurchase agreements, official swap arrangements); (ii) suppliers’ credits; and (iii) leases (debt measured as present value at inception of all lease payments expected).
  - Under this definition, arrears, penalties, and judicially awarded damages arising from failure to make payment under a contractual obligation that constitutes debt are debt.
  - Failure to pay an obligation not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.
- Standard continuous performance criteria also include prohibitions on:
  - Imposition or intensification of restrictions on payments and transfers for current international transactions.
  - Introduction or modification of multiple currency practices.
  - Conclusion of bilateral payments agreements inconsistent with Article VIII.
  - Imposition or intensification of import restrictions for balance of payments reasons.

### Provision of information to the IMF and data reporting requirements (high-level)
- Performance monitored using data supplied by the Ministry of Finance (MOF) and the NRB as specified in Table 5; authorities will transmit data revisions within 14 days after being made and immediately provide any data indicating non-observance of continuous performance criteria.
- Authorities will inform IMF staff immediately of the creation of any new extra-budgetary funds or programs.
- Selected reporting requirements and submission lags (exact frequencies and lags preserved in the source):
  - Ministry of Finance:
    - Summary of budgetary central government accounts (FCGO monthly reports): M, 30 calendar days.
    - Summary of net incurrence of liabilities (PDMO monthly reports): Q, 30 calendar days.
    - Domestic and external public debt stock and debt service costs (PDMO quarterly reports): A, 60 calendar days.
    - Debt guarantees by budgetary central government and NRB (PDMO and NRB quarterly reports): Q, 45 calendar days.
    - Audited financial statements of public enterprises: A, 210 calendar days.
    - Social spending data on specified programs: H, 30 calendar days.
    - Data on the child grant program: H, 30 calendar days.
    - The Annual Budget (Budget speech with annex): A, 30 calendar days after delivery of the budget speech.
    - Mid-year budget review: A, 30 calendar days after January 15.
    - Annual budget execution report (FCGO): A, 90 calendar days.
    - National accounts data: A, Q, 90 calendar days.
  - Public Debt Management Office:
    - Stock of outstanding external debt payment arrears of the general government (if any) by creditor: Q, 30 calendar days.
  - Nepal Rastra Bank:
    - Exchange rate data (monthly official rates NPR/$ submitted once a week for the previous week; monthly average buy and sell rates): M, 5 working days after the end of the month.
    - Monthly consumer price indexes (CPIs): M, 30 calendar days.
    - Program net international reserves and its components: M, 7 working days.
    - Breakdown of gross foreign assets and liabilities by currency: M, 15 calendar days.
    - Balance of payments (BPM6): M, 30 calendar days.
    - International investment position and private and public external debt data: Q, 90 calendar days.
    - Data on remittances, tourist arrivals, imports and exports by HS-2, central bank balance sheet summary, government balances at NRB, monetary operations, interbank and T-bill rates and volumes, central bank liquidity data, loan portfolio review progress, FX purchases/sales, interbank FX turnover: specified frequencies and lags in Table 5.
  - Commercial bank and BFI reporting (condensed and detailed bank-by-bank data) with specified monthly lags (including 75 calendar days for certain bank-by-bank breakdowns).

### Debt Sustainability Analysis (summary findings and key figures)
- Both external and overall public debts in Nepal are assessed at low risk of debt distress, unchanged from last year’s Debt Sustainability Analysis (DSA).
- Mechanical indicators:
  - PV of external debt-to-exports ratio and external debt service-to-exports ratio breach indicative thresholds under an export shock scenario, mechanically suggesting moderate risk, but staff judgment overrides the mechanical signal.
- Rationale for judgment override:
  - Nepal’s exceptionally high level of remittances (over three times exports) makes the debt-to-exports ratio a less relevant signal of debt distress.
  - Remittances, along with concessional external financing, support reserves and debt servicing despite a sizable trade deficit.
- Other indicators:
  - All other external and public debt risk indicators are below their respective indicative thresholds in all stress-tests.
- Key numbers and projections:
  - Public debt stood at 47 percent of GDP in FY2022/23.
  - Debt is projected to peak at 50 percent of GDP in FY2025/26 and to gradually subside afterwards.
  - The composite indicator (CI) score is calculated at 3.14 (based on the October 2023 WEO and the 2022 World Bank CPIA index).
  - Assessment contingent on continued fiscal consolidation, tax revenue and spending reforms, continued utilization of external borrowing at concessional terms, and structural reforms to diversify exports and enhance resilience.
- Administrative/approval metadata preserved from source:
  - Approved by Rupa Duttagupta and Fabian Valencia (IMF) and Manuela Francisco and Mathew Verghis (IDA).
  - Joint Bank-Fund Debt Sustainability Analysis.
  - Risk of External Debt Distress: Low.
  - Overall Risk of debt Distress: Low.
  - Granularity in the Risk Rating: No Applicable.
  - Application of Judgment: Yes.
  - Date noted in source: June, 21 2024.

*Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1nplea2024001-print-pdf.pdf*

### 1.      Public debt in this DSA comprises debt from the general government, central bank

### Public debt in Nepal: coverage, risks, and outlook (DSA extract)

### Public debt coverage and definition
- Public debt in this DSA comprises debt from the general government, central bank (borrowing on behalf of the government) and government guarantees.
- Nepal’s provincial and local governments have no debt; borrowing is permitted by the Public Debt Management Act of 2022 but has not yet commenced (except on-lending by the central government).
- The social security fund and other extra budgetary funds currently are not allowed to borrow and do not have debt.
- IMF disbursements in 2020-2023 were used for direct budget support; central bank bond issuances were only for monetary policy operations.
- Government guarantees for SOE debts total NPR 46 billion (0.9 percent of GDP) and are included in the debt stock.
- The negative balance of the Treasury Single Account (TSA) is treated as government gross debt under the LIC DSF.
  - Net balance across all government accounts was about 5 percent of GDP in Q3 of FY2023/24.
  - The negative TSA balance stood at 3.4 percent of GDP in FY2022/23, up from 1.2 percent of GDP in FY2021/22.
  - Other cash balances cannot be used to offset the negative TSA balance for LIC DSF gross debt measurement.

### Contingent liabilities and stress testing
- The contingent liability stress test (default setting) includes:
  - SOE debt: 2 percent of GDP
  - PPP projects: 2.1 percent of GDP
  - Financial market shock: 5 percent of GDP
- PPP projects have not been formally compiled by the government; the World Bank PPI database estimates PPP contracts at 6 percent of GDP as of 2022.
- Net Acquisition of Financial Assets (NAFA) is already incorporated in the baseline and averaged 1.4 percent of GDP annually since 2009; it fell to -0.9 percent of GDP in FY2022/23.
  - The program baseline assumes NAFA will pick up and remain close to its long-term average.
- The standard 2 percent of GDP risk for SOE contingent liabilities is considered appropriate; it covers about a fifth of total financial liabilities in all non-financial SOEs and all financial liabilities in Nepal Airlines Corporation.
- The standard 5 percent of GDP financial market default risk is judged appropriate given currently adequate bank capitalization, but signs of stress exist in the financial sector (growing non-performing loans, lower capitalization, stagnant private credit).
- Planned and recommended policy actions to reduce contingent liability risks:
  - Timely publication and audit of SOE financial statements (envisaged in the ECF program, end-August 2024 SB).
  - Expand the fiscal risk registry to include subnational governments and PPPs and publish a comprehensive fiscal risk statement with the FY2025/26 budget (end-August 2025 SB).
  - Conduct the loan portfolio review (LPR) in the ten largest banks by the NRB and use results to calibrate financial market default risk.

### Public debt management developments
- Public Debt Management Act (PDMA) enacted October 2022 consolidates debt management in the Public Debt Management Office (PDMO) and sets a limit on external public debt at one third of past fiscal year’s GDP.
- PDMO took over domestic debt issuance functions from the Nepal Rastra Bank (NRB) in April 2024 and progressed towards dematerializing debt securities.
- The Debt Management Committee is now chaired by the Revenue Secretary to separate domestic debt management from monetary policy.
- The Medium-Term Debt Strategy (MTDS) has been published at the PDMO’s website with annual update intent and use in the budget process.
- A fiscal risk register was implemented in August 2023 to identify, disclose, and manage fiscal risks, including those from SOEs and guarantees.
- Remaining weaknesses and recommended improvements:
  - Resource constraints and frequent staff rotation at PDMO slow PDMA implementation.
  - Strengthen middle- and back-office functions: mainstream cash flow forecasting, integrate with debt management, anchor annual borrowing and issuance plans on the MTDS and market considerations.

### Debt trajectory, composition, and financing
- Total public debt rose from 25 percent of GDP in FY2015/16 to 47 percent in FY2022/23.
- External public debt characteristics:
  - Multilateral creditors (IDA and ADB) represent 87 percent of the total external debt.
  - External loan terms: average interest rate 1 percent; average maturity around 36 years.
  - Present value (PV) of external debt estimated at 14.5 percent of GDP in FY2022/23.
  - External debt-to-GDP ratio has been nearly constant since the pandemic.
- Domestic public debt:
  - Increased from 10.1 percent of GDP in FY2015/16 to 25 percent in FY2022/23.
  - Composition: about one-third in short-term treasury bills (maturity up to 1 year); close to sixty percent in medium- to long-term development bonds (maturities of 3-7 years).
  - Debt held mainly by domestic financial institutions.
  - Interest rates on domestic borrowing rose by over 6 percentage points in FY2021/22; over 85 percent of total government interest spending in FY2022/23 (1.3 percent of GDP) was to pay interest on domestic debt.
  - Interest rates have since fallen to 3-4 percent (depending on instrument).
- Private external debt:
  - Low but rising: about 0.5 percent of GDP in FY2019/20; estimated 2.2 percent of GDP in FY2022/23.
  - Assumed to increase to 3 percent of GDP (private medium-and long-term external debt) and total private external debt to reach 4.5 percent of GDP in the long term.
  - Most private external borrowing to date by banks and hydropower projects.

### Macroeconomic context and fiscal outlook
- Growth and inflation:
  - Real GDP growth in FY2022/23: 2.0 percent (versus 4.4 percent projected in last DSA).
  - Inflation in FY2022/23: 7.8 percent.
  - Inflation projected at 5.6 percent in FY2023/24 and converge to around 5.4 percent in the medium and long term.
  - Real GDP growth projected at 3.1 percent in FY2023/24.
- Structural drivers and risks:
  - Medium-term growth projected to revert to around 5 percent, contingent on structural reforms (including ECF), take-up of concessional external financing, tourism expansion, hydropower production and exports, and better public investment management.
  - Climate change and disaster vulnerability have led to a slight downward revision of the medium- and long-term growth forecast relative to the prior DSA.
- Fiscal balances and NAFA:
  - Primary deficit FY2022/23: 4.5 percent of GDP (up from 2.2 percent in FY2021/22).
  - Primary deficit projected to shrink to 3 percent in FY2023/24 amid spending cuts of about 3.5 percent of GDP announced in January 2024 mid-term budget review.
  - Medium-term primary deficit projected to subside to 1.4 percent of GDP, consistent with the ECF program framework.
  - Fiscal consolidation measures include green tax on petroleum products, higher taxes on vehicles, increased excise duties on alcohol and tobacco, and measures to improve tax compliance (FY2024/25 budget).
  - Debt-stabilizing primary deficit estimated around 3.2 percent of GDP; continuation of sizeable NAFA implies a much lower level of about 1.9 percent of GDP.
  - Authorities sharply reduced NAFA in FY2022/23 to reduce fiscal pressure; the fiscal path assumes NAFA remains broadly at historical average.

*Source: IMF DSA chapter on Nepal (extracted content).*

### 15.      External sector: The current account (CA) deficit shrank from 12.7 percent in    FY2021/22 to just

### 15.      External sector: The current account (CA) deficit shrank from 12.7 percent in    FY2021/22 to just

### External sector: current account, exports, remittances, and reserves
- CA deficit narrowed from "12.7 percent in FY2021/22" to "1.4 percent in FY2022/23" and is projected to reverse into a surplus in "FY2023/24".
- Medium-term CA projection: revert to a deficit of "about 3.6 percent of GDP".
- Drivers of recent outperformance:
  - Sharp drop in imports amid slowing economy.
  - Continued post-pandemic recovery in remittances and tourism services.
  - Stronger-than-expected recovery in tourism, which comprises "over forty percent of total exports".
  - Healthy growth in exports of agricultural and industrial items, including cement and clinker, and hydropower.
- Hydropower:
  - Exports of hydropower are projected to grow by "50 percent already in FY2023/24".
  - Projection for hydropower export is described as fairly conservative—assuming a quadrupling over the next 10 year from a relatively low base in "FY2022/23".
  - A recently signed agreement aims to export "10,000 MW to India in 10 years"—about a ten-fold increase from current levels; if realized, it would present a significant upside to the projections.
- Exports are expected to gradually reach "around 7.7 percent of GDP" in the medium-term, supported by hydropower growth.
- Remittances:
  - Expected to decline as a percent of GDP but remain sizeable at "about 21 percent of GDP over the medium term".
- International reserves:
  - Projected to reach "9.4 months of prospective imports in FY2023/24".
  - Projected to remain high in the medium term at "7-8 months of prospective imports".

### Financing: external and domestic borrowing dynamics
- External government financing decreased in "2021-23" in nominal terms and as a share of GDP as authorities relied more on domestic borrowing and tapped the TSA.
- Concessional loans from development partners, mainly multilateral development banks, are expected to remain a key source of funding to cover BOP and fiscal financing needs next year and in the medium term.
- Size of external financing is projected at "about 1.4 percent of GDP in the medium term"—lower than "1.9 percent of GDP" projected in the last DSA.
- Domestic borrowing is projected to cover about "two thirds of fiscal financing needs over the medium and long term", while remaining costlier and generally riskier than external concessional funding.
- Interest rate projections:
  - Domestic borrowing interest rates projected to pick up from presently low levels to reach "about 5-6 percent over the medium-term"—in line with projected inflation and an assumption of less financial repression.
  - Interest rate on newly issued external debt and other concessional elements projected to remain broadly unchanged.
- About "a third" of newly-issued domestic debt is assumed to be short-term—subject to significant refinancing risk.
- External borrowing is subject to exchange rate risk (described as low so far) but borrowing terms are extremely favorable compared to Frontier and Emerging Market economies.

### Realism checks and debt dynamics
- Unexpected changes in public and external debt over the last five years are within the "25-75 percent interquartile range" across all LICs.
- Public debt-creating flows over the next five years are similar to the 5-year historical average; contribution of future GDP growth and primary deficit is lower than historical due to pandemic effects and authorities’ commitment to stabilize debt.
- External debt-creating flows show a much smaller contribution of the current account partly offset by reserve accumulation.
- Projected 3-year fiscal adjustment is marginally above the "75th percentile" across all LICs with Fund-supported programs since 1990; about half of the adjustment is already visible 10 months into the fiscal year and likely to materialize in "FY2023/24".
- Effect on growth: projected impact of adjustment on economic growth is lower than implied by conventional fiscal multipliers; part of adjustment reflects reverse causality from economic recovery and import rebound increasing revenue.
- Implied impact of public investment on growth is more conservative than historical; more targeted and efficient capital spending would present an upside and reduce spillovers from fiscal consolidation.

### Country classification and tailored stress tests
- Debt carrying capacity (CI):
  - Nepal’s CI score is calculated at "3.14" based on October 2023 WEO and the 2022 World Bank CPIA index—lying in the "Strong" rating range.
  - CI components summary (as presented): CPIA contribution, real growth, import coverage of reserves, remittances, and world economic growth yield CI Score "3.14".
- Applicable thresholds under new framework:
  - TOTAL public debt benchmark: PV of debt in % of GDP "70".
  - Exports threshold: "240" (PV of total public debt in percent of exports).
  - GDP threshold: "55".
  - Debt service in % of Exports: "21".
  - Debt service in % of Revenue: "23".
- Tailored stress tests:
  - All stress tests kept at default settings; a natural disaster shock applied given Nepal’s vulnerability.
  - Natural disaster shock: one-off shock of "10 percentage points of GDP" to the debt-to-GDP ratio in the second year ("FY2024/25"), with real GDP growth and exports lowered by "1.5" and "3.5 percentage points", respectively, in the year of the shock.

### External debt sustainability and vulnerabilities
- Under the baseline, all external debt indicators remain below their indicative thresholds.
- External debt in "FY2022/23" was significantly lower than projected in the last DSA despite worse-than-expected automatic dynamics (e.g., lower GDP growth).
- Factors contributing to lower external debt:
  - Stronger US dollar in 2022 favored Nepal because over "three quarters" of Nepal’s external debt is nominated in SDR, and another "ten percent" is denominated in currencies other than US dollar or SDR.
  - Lower-than-projected external financing in "FY2022/23".
- PPG external debt trajectory:
  - Projected to decline gradually to about "18 percent of GDP by FY2033/34".
  - PV of PPG external debt-to-GDP ratio projected to hover at "about 12-14 percent" in the medium term—well below 55 threshold.
  - PV of PPG external debt-to-exports ratio is below threshold but relatively high due to Nepal’s very low exports-to-GDP ratio.
  - Other indicators (debt service-to-exports, debt service-to-revenue) are all below respective thresholds.

### Stress test outcomes and key sensitivities
- External debt is most vulnerable to export shocks:
  - PV of PPG external debt-to-exports ratio and external debt service-to-export ratio breach thresholds in an export shock scenario.
  - External debt service-to-export ratio breach is marginal (close to "5 percent") and temporary (lasting 2 years: "FY2025/26 and FY2026/27").
  - Export shock calibration draws on export volatility over last ten years, including the "2015 earthquake" and the "2020 pandemic", and a one-off "46 percent" spike in exports in "FY2021/22" due to palm oil re-export driven by a now-removed tariff loophole.
  - Breach partly reflects larger implied volatility of exports and SDR appreciation against the US dollar increasing repayments on SDR-denominated debt.
- Public debt vulnerability:
  - Under baseline, PV of public debt-to-GDP ratio remains firmly below the "70 percent" benchmark.
  - Public debt projected to peak at around "50 percent of GDP in FY2025/26" and gradually subside after.
  - PV of debt-to-GDP ratio expected to increase from "40 to a peak of 43 percent of GDP"—well below 70 benchmark.
  - Debt service-to-revenue ratio is relatively high at "over 50 percent" because close to a third of domestic debt is short-term and revenue-to-GDP ratio has recently fallen.
- Public debt is most vulnerable to a growth shock:
  - Growth shock defined as temporary shock to real GDP growth in the second and third year of projections set to either the 10-year historical average growth minus one standard deviation or projected growth minus one standard deviation, whichever is lower.
  - Under the growth shock the PV of debt-to-GDP ratio would rise close to the "70 percent" threshold in "2034", but none of the thresholds are breached.
  - Calibration of growth shock is large for Nepal because the period includes the "2015 earthquake" and the "2020 pandemic".

### Other factors, judgement, and mitigating elements
- Remittances:
  - Major source of foreign exchange; remittance-to-GDP ratio averaged "24 percent of GDP in 2018-2023"—the fourth largest in the world.
  - Remittance-to-exports ratio is by far the largest in the world (2018-22 averages).
  - Remittances have been less volatile than exports: standard deviation of remittance growth "7.4 percent" versus "19.3 percent" for export growth over the last 10 years.
  - Current level of remittances is well above "7 percent of GDP"—the minimum needed, everything else equal, to maintain the strong CI rating.
- Net errors and omissions:
  - Consistently positive and large (averaging "over 2 percent of GDP in the last 5 years"), indicating large unaccounted foreign exchange inflows that contribute to residuals in external debt dynamics.
  - BoP transition to BPM6 accounting (IMF TA June 2024) expected to improve official estimates and potentially reduce net errors and omissions and possibly increase official exports and/or remittances.
- Overall assessment: stress test breaches on PV of debt-to-exports and debt service-to-exports require judgement given exceptionally high remittances and resilience of other debt burden metrics; low exports and their volatility remain major vulnerabilities.

### Risk ratings and overall assessment
- Risk ratings:
  - Risk of both public external debt distress and overall debt distress assessed as "low".
  - All debt indicators remain below relevant indicative thresholds under the baseline; PV of public debt remains below threshold under all stress tests.
  - Mechanical medium risk signal from export shock (due to breaches) was judged down to low risk given remittances and other factors.
- Supporting factors for low risk assessment:
  - PV of PPG external debt is "14.5 percent of GDP in FY2022/23"—well below the indicative threshold of 55.
  - External debt indicators below thresholds in baseline and shocks across other metrics (PV of debt-to-GDP and external debt service-to-revenues) reflecting high concessionality and low cost of external debt servicing.
  - High and increasing international reserves projected to remain well above adequacy in medium and long term.
  - Authorities achieved considerable fiscal consolidation in "FY2022/23" and (projected) "FY2023/24" and kept public debt broadly in line with previous DSA projections.
  - Exports of goods and services in "FY2022/23" and (projected) "FY2023/24" grew faster than previously projected; hydropower presents upside prospects.

### Policy recommendations to mitigate risks and build resilience
- Improve productivity and competitiveness by:
  - Stepping up investment in resilient and sustainable infrastructure.
  - Streamlining regulations and administrative processes.
  - Sustaining stronger domestic revenue mobilization.
- Rigorous analysis and monitoring of contingent liabilities, including:
  - Non-guaranteed commercial SOE debt.
  - Unfunded pension liabilities.
  - PPP projects.
  - Budget support for the financial sector, including SACCOs.
- Improve subnational governments’ public financial management and reporting.
- Mainstream medium-term debt strategy (MTDS) and cash flow forecasting.
- Develop the government bond market further to facilitate domestic borrowing and move toward longer maturity debt replacing short-term bills.
- Boost effort to utilize external borrowing at concessional terms to close infrastructure gaps.
- Ensure prudent execution of medium-term fiscal consolidation strategy, including tax revenue and spending reforms envisaged in the ECF arrangement.

*Source: Excerpt from IMF Country Report (Nepal) — External sector, financing, debt sustainability, and policy recommendations.*

### 27.      The authorities broadly agreed with the assessment. They reiterated their commitment to

### Statement by Yati Kurniati, Executive Director for Nepal; Raja Anwar, Alternate Executive Director; and Siddha Raj Bhatta, Advisor to the Executive Director — July 09, 2024

### Authorities' agreement and debt anchors
- The authorities "broadly concur with the staff analysis" and "are committed to implementing the reforms agreed under the ECF program arrangements."
- Legislative and institutional anchors cited:
  - Public Debt Management Act external debt limit: 33 percent of the previous year’s GDP.
  - Annual limits on domestic borrowing set by the Natural Resource Commission.
- Concessional external borrowing is prioritized, with concern that availability and conditions may worsen as Nepal graduates from Least Developed Country status, scheduled for 2026.
- External debt was 21.9 percent of GDP at the end of FY 2022/23.
- Public debt is expected to stabilize at around 50 percent of GDP by FY 2026/27, a year earlier than projected in the third review.
- Both public and external debt are assessed to be at "low risk of debt distress."

### Economic outlook and key indicators
- Growth: "The Nepali economy is rebounding" and "will grow at a faster pace in FY2024/25 and strengthen further in FY2025/26."
- Inflation: "Consumer inflation declined to 4.4 percent in May 2024, a 31-month low, after reaching 8.6 percent in September 2022."
- External sector and reserves:
  - "The current account registered a surplus."
  - "International reserve position has substantially improved, providing a cushion to imports for 12.6 months as of May 2024."
- Financial sector: "Financial sector consolidation is progressing in line with program objectives."

### ECF program implementation and performance criteria
- Program status: "ECF program implementation remains satisfactory."
- Performance criteria met: "comfortably met the performance criterion (PC) on net international reserves and primary fiscal deficit."
- Indicative target (IT) on child grant spending: missed due to transition to an electronic payment mechanism; authorities reaffirm efforts to meet the IT before the end of the current fiscal year.
- Structural benchmarks (SBs): Out of five SBs, three have been met (one with delay); the remaining two SBs have been proposed to be reset.
- Continuous PCs: "All continuous PCs have been met."

### Monetary policy
- Nepal Rastra Bank (NRB) stance: "continue its cautious and data-driven monetary policy approach."
- Policy actions: NRB "cautiously loosened its monetary policy stance in December 2023" to support subdued credit growth.
- Implementation of the standing deposit facility has helped stabilize the interbank rate in line with the Interest Rate Corridor (IRC) framework.
- Commitment to "further strengthening implementation of the monetary policy framework to enhance the clarity and credibility of monetary policy."

### Fiscal policy and public financial management
- Fiscal priorities: "fiscal reforms ... to strengthen fiscal sustainability and rebuild buffers."
- Domestic Revenue Mobilization Strategy (DRMS): recently approved; authorities "fully committed to implementing the measures specified in the DRMS."
- 2024/25 budget measures: green tax on petroleum products; increase in excise duties on alcohol, beer and tobacco; initiatives for improving tax compliance.
- Spending focus: contain recurrent expenditure through rationalization with sub-national governments and administrative costs; continue support for food security and poverty reduction.
- Public financial management reforms:
  - Plan to formulate a Public Financial Management Improvement Strategy based on the third PEFA assessment.
  - Revising National Project Bank Operational Procedures in line with PIMA action plan.
  - Strengthening fiscal risk registry and cash flow forecasting framework.
- Public enterprise audits and reporting:
  - Audits of three of the four priority nonfinancial public enterprises (PEs) completed; remaining audit to be completed by August 2024.
  - Preparing to publish the FY2022/23 annual financial statements of all majority and wholly-owned PEs by August 2024.

### Financial sector stability and reform measures
- System soundness: non-performing loan ratio "remains below 5 percent" despite increases; capital adequacy and liquidity ratios are above regulatory minimums.
- Regulatory and supervisory steps:
  - Allowed banks to raise additional capital through perpetual non-cumulative preference shares.
  - Asset Classification Guidelines, Working Capital Loan Guidelines, and reintroduction of countercyclical buffer enacted.
  - Implementation of the Supervisory Information System (SIS) expected to support supervision.
  - Plan to introduce Basel III liquidity coverage ratio for banks.
- Bank-specific actions: committed to completing loan portfolio review of the ten largest banks within ECF-agreed time limits.
- SACCO sector: plan to establish and operationalize a specialized regulatory authority with a new regulatory framework and supervisory architecture to mitigate risks.
- Authorities committed to implementing recommendations of the Financial Sector Stability Review (FSSR) and welcome technical assistance.

### Governance, transparency, and structural reforms
- Priorities: structural reforms to address bottlenecks, enhance output, productivity, and competition; FY2024/25 declared "Economic Reform Year."
- Five strategies in the budget for economic reforms, including structural reforms, improving the business environment, public financial system reforms, financial sector reforms, and public administration reforms.
- Governance improvements:
  - Committed to implementing feasible recommendations of the 2021 Safeguards Assessment to strengthen central bank autonomy and governance.
  - Passed amendments to AML/CFT laws and working on a national strategy to address deficiencies.
  - Committed to implementing reforms to address findings of the Asia-Pacific Group on money laundering’s 2023 assessment.
  - Planning to introduce a risk-based evaluation system for controlling financial crimes and intensive supervision for high-risk sectors (casinos, precious metals, cooperatives, real estate, remittance, and banking).

### Conclusion and request
- Authorities view the ECF program as helpful "in maintaining macroeconomic stability and in implementing governance and structural reforms."
- They reiterate "their strong commitment to program objectives" and request completion of the Fourth Review.
- Authorities "fully agree that the accompanying structural reforms are well-aligned with domestic policy priorities" and express thanks to the IMF Executive Board, Management and Staff, and international partners for continued support.

*Statement by Yati Kurniati, Executive Director for Nepal; Raja Anwar, Alternate Executive Director; and Siddha Raj Bhatta, Advisor to the Executive Director — July 09, 2024*

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_Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1nplea2024001-print-pdf.pdf_