## Nepal—Assessment Letter for the World Bank May 29, 2015

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### Pre-earthquake macroeconomic performance
- Growth accelerated to 5.5 percent in 2013/14, thanks largely to a favorable monsoon.
- Inflation had been moderating, broadly in line with developments in India, but remained high at 7 percent (y/y) in March 2015.
- Fiscal position in 2013/14 (mid-July 2013 to mid-July 2014) was again in surplus on account of under-execution of spending amid solid revenue growth.
  - Public debt eased further, to 25 percent of GDP.
  - The trend of budget under-execution continued through April 2015, indicating that a small fiscal surplus looked again likely in 2014/15.
  - Public debt remained on a declining path.
- External position remained strong in 2013/14:
  - The current account surplus reached 4.6 percent of GDP in 2013/14, as remittances continued to grow rapidly, reaching a record-high 28 percent of GDP.
  - Net of remittances, Nepal ran a current account deficit of 23.6 percent of GDP in 2013/14.
  - International reserves rose to US$6.2 billion by March 2015, equal to 29 percent of GDP and covering almost eight months of prospective imports.

### Earthquake impact and reconstruction implications
- Immediate effects and financing:
  - The earthquakes are expected to cause an initial slowdown in economic activity and to strain Nepal’s external position.
  - Pending the completion of the Post-Disaster Needs Assessment it is too early to provide estimates of the damage.
  - Nepal’s Cabinet has established a US$2 billion (about 10 percent of GDP) Earthquake Relief Fund for Reconstruction and Rehabilitation.
  - Damage to property has adversely affected productive capacity.
  - The tourism sector, which generated about 2½ percent of GDP in foreign currency earnings in 2013/14, has been hit.
- Determinants of growth recovery:
  - The growth recovery will largely be determined by the vigor of the reconstruction effort.
  - Two components to the expected increase in reconstruction activity:
    - The large-scale import needs related to public sector reconstruction will strain Nepal’s external position and the pace of public sector reconstruction will importantly depend on the amount of external finance Nepal receives to rebuild. Alternatively, without the mobilization of substantial additional aid, foreign reserves would be expected to fall significantly over the medium term.
    - Private sector reconstruction will largely be driven and financed by remittances.
  - Speed of recovery also depends on absorptive capacity (addressing implementation bottlenecks) and effective coordination among donors.

### Risks to the outlook (non-earthquake)
- External risks:
  - Slowdown in host countries for Nepali workers, especially in oil-exporting countries (e.g., the GCC countries and Malaysia).
  - Potential slower-than-anticipated recovery in India, Nepal’s largest trading partner.
- Domestic risks:
  - Financial sector vulnerabilities identified in the 2014 FSAP, including asset quality issues, interconnections in the financial system, financial sector infrastructure weaknesses (including the legal framework), and supervision and crisis preparedness.
  - Rapid growth of a largely unsupervised credit cooperatives sector.
  - Political instability which could undermine confidence and delay economic reforms.

### Policy priorities and recommendations
- Fiscal policy and public investment:
  - There was fiscal space to significantly boost investment in public infrastructure (power and transport) without endangering debt sustainability prior to the earthquakes.
  - The joint World Bank-IMF DSA conducted in the 2014 Article IV cycle rated Nepal at “low” risk of debt distress; staff believes this rating continues to be warranted, as little new debt has been incurred.
  - Post-earthquake reconstruction needs add urgency to addressing institutional constraints—including in the budget planning and execution processes—that impede efficient execution of the capital budget.
  - Recent IMF Fiscal Affairs Department technical assistance provided detailed recommendations to address implementation bottlenecks.
- Financial sector policy and supervision:
  - Widespread earthquake-related damage to property could expose financial sector vulnerabilities identified in the 2014 FSAP.
  - The Nepal Rastra Bank (NRB) has taken macro-prudential measures in recent years and improved supervision, but should:
    - Strengthen capacity further.
    - Use corrective and sanctioning powers more fully.
    - Respond decisively to possible instances of financial distress caused by the earthquakes.
- Monetary policy and exchange rate:
  - The exchange rate peg with the Indian rupee serves as a transparent anchor for monetary policy and continues to benefit Nepal given its close economic relationship with India.
  - Monetary policy should aim at controlling the level and volatility of excess liquidity to keep Nepalese inflation in the neighborhood of that in India.
  - Liquidity management may be complicated by increased aid and remittances flows.

### IMF relations and support
- The joint IMF-World Bank FSAP was completed in mid-2014.
- The 2014 Article IV consultation was concluded by the IMF’s Executive Board on July 3, 2014.
- An IMF mission visited Nepal during May 10-15, 2015 to help assess the macroeconomic impact of the earthquakes.
- Staff is planning a follow-up mission to discuss the provision of financial support through the Rapid Credit Facility.
- In recent years, the Fund has provided technical assistance in the areas of tax administration, tax policy, public expenditure management, monetary policy operations, banking supervision, and macroeconomic statistics.

*Source: Nepal—Assessment Letter for the World Bank, May 29, 2015.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_052915.pdf_