## _cr08181

## Source details

**Canonical URL:** [_cr08181](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08181.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08181.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08181.pdf.json)

---

### Executive summary — background and vulnerabilities
- Macroeconomic performance: growth maintained at low levels; inflation stable; cautious budget stance; foreign exchange reserves ample.
- Structural and financial sector vulnerabilities:
  - Rapid credit growth, loose monetary conditions, and weak central bank supervision persist.
  - Losses of the state oil company mounting; Nepal Oil Corporation running an annualized deficit of about 1½ percent to 2 percent of GDP at current crude prices.
- Political risks:
  - Unsettled political circumstances pose the most immediate risk to macroeconomic stability and growth; demands of the peace process could pressure greater public spending.

### Key macroeconomic findings and indicators
- Growth and inflation
  - Output growth averaged 3 percent since 2002.
  - Outlook for 2007/08: staff projection of real GDP growth of 3½–4 percent; authorities argued growth could reach 4½ percent.
  - Inflation projected to remain broadly stable around 6½ percent to 7 percent.
- External position and remittances
  - Foreign exchange reserves: $2 billion, or 6 months of imports (reserves of the central bank doubled since 2002).
  - Workers’ remittances expected to grow by 20 percent over last year (2007/08 projection).
  - Remittance inflows reported at over $1½ billion; annual remittance flows now exceed 15 percent of GDP.
  - About one million Nepalese estimated to be working in India.
- Exchange rate and competitiveness
  - Real exchange rate appreciated by 20 percent over the last three years, driven largely by the decline in the dollar against the Indian rupee.
  - With 70 percent of exports going to India, measured REER may overstate impact on export competitiveness.
- Fiscal and public debt
  - Revenue growth averaged 15 percent per year.
  - Public debt reduced to below 50 percent of GDP.
  - Budget deficit could rise this year to about 3½ percent of GDP.
  - Authorities aim to limit domestic borrowing in the next budget to 1-2 percent of GDP.
- Financial sector and monetary conditions
  - Negative real interest rates; rapid and potentially destabilizing stock market and property price increases; some capital flight to India.
  - Credit growth high; many banks’ credit-to-deposit ratios above 100 percent in some cases.
  - Total assets of the banking system to GDP stood at 81 percent in July 2007.
  - Credit growth around 25 percent system-wide; lending by private commercial banks at 36 percent.
  - System-wide average credit-to-deposit (CD) ratio increased from 60 percent over 2000–2006 to 78 percent by end-2007.
  - Nearly 25 percent of banking assets held by smaller private banks with CD ratios exceeding 90 percent.
  - Nearly 60 percent of bank loans secured by real estate assets; lending against stocks as collateral about 3 percent of bank loan portfolios.
- Public enterprises
  - Nepal Oil Corporation: flow losses should be covered by the budget in a timely and transparent manner; preferred permanent solution is an automatic pricing mechanism.

### Exchange rate peg, remittances, and external balance
- Role of the peg
  - Peg to the Indian rupee (in place since 1993) anchored inflation and served Nepal well given integration with India.
  - Staff view: maintaining the peg appropriate for Nepal’s macroeconomic stability in the near term.
- Remittances’ role
  - Workers’ remittances are more important than exports as a source of foreign exchange; trade balance combined with remittances much more stable than merchandise trade alone.
  - Nepal’s balance of payments in surplus for the last decade, with annual reserve accumulation around $150 million over the last five years.
- Assessment and risks
  - Current exchange rate level appears broadly consistent with equilibrium.
  - Attempts at step devaluation unlikely to be effective and could be eroded by higher inflation and increased domestic liquidity.
  - Potential future challenge: faster productivity growth in India may require domestic factor market flexibility; more flexible regimes could help smooth adjustment.

### Monetary policy, liquidity management, and recommended actions
- Staff recommendation: tighten monetary conditions to address negative real interest rates, rapid credit growth, destabilizing asset prices, and some capital flight.
- Actions advised:
  - Better liquidity management and forecasting.
  - Separation of formulation and execution of monetary policy from public debt management.
  - Increased use of open market operations; NRB has tools including outright sale/purchase auctions, repo and reverse repo auctions.
  - Improve interbank market functioning to avoid uneven liquidity distribution as seen in January temporary credit squeeze.
- Authorities’ measures:
  - NRB directive on margin lending issued on January 22, 2008.
  - Liquidity monitoring and forecasting framework (LMFF) based on weekly NRB balance sheet guides operations.
  - NRB committed to modulate liquidity through appropriate policy actions.

### Financial sector risks and reform priorities
- Key concerns and indicators
  - Commercial banks increased from 17 to 23 in the last three years.
  - Deposit-taking nonbank financial institutions nearly doubled in 2007 to 139 institutions.
  - Credit growth around 25 percent system-wide; private commercial bank lending at 36 percent.
  - Concentration of collateral: nearly 60 percent of bank loans secured by real estate.
- Staff recommendations
  - Strengthen supervision and regulatory enforcement; enforce the Banking and Financial Institutions Act once approved by parliament.
  - Take action against private banks violating capital adequacy requirements; enforce single-borrower limits.
  - Enforce stricter licensing requirements approved in April 2007, including “fit and proper” tests.
  - Continue movement toward risk-based supervision and implement Basel II beginning July 2008.
  - Adopt a clear strategy to commercialize the two large public banks to achieve solvency and commercial operation.
  - Improve debt collection enforcement (including via the Debt Recovery Tribunal).

### Fiscal policy, public financial management, and public enterprises
- Fiscal stance and indicators
  - Net fiscal deficit in 2006/07: 1.4 percent of GDP.
  - Net domestic financing of budget deficit in 2006/07: 0.9 percent of GDP.
  - Revenue growth showing 25.3 percent (as presented by authorities).
  - Government extended loans of 4 billion rupees to NOC in the current fiscal year.
- Policy recommendations
  - Preserve budget discipline to support pegged exchange rate.
  - Limit domestic borrowing to 1-2 percent of GDP in the next budget.
  - Limit and eventually eliminate NOC losses; preferred permanent solution: automatic pricing mechanism for petroleum products.
  - Improve revenue collection and broaden Large Taxpayer Office progress.
  - Accelerate reforms: improve coverage of financial information, accounting system, develop chart of accounts, and lay groundwork for a treasury single account.
  - Reduce reliance on domestic financing to avoid a growing interest bill.

### LIC-DSA findings and external/public debt projections
- Country classification and thresholds
  - Nepal classified as a medium performer based on three year average CPIA score during 2004-06.
  - At end-2007, NPV of public debt-to-exports ratio estimated at 148 percent (indicative threshold 150 percent).
- Baseline projections (2007/08–2027/28)
  - NPV of external public debt-to-GDP: decline from 20 percent to around 12 percent.
  - NPV of external public debt-to-exports: fall from 148 percent to 87 percent.
  - External public debt service-to-exports ratio: decline from 9 percent to 6 percent.
  - NPV of public debt-to-GDP (baseline): declines from 35 percent at end 2007/08 to 26 percent by 2027/28.
  - NPV of public debt-to-revenue ratio: falls from 216 percent to 157 percent.
  - Public debt service-to-revenue ratio: decreases from 17 percent to 12 percent.
- Sensitivity and stress tests
  - A shock modeled as real GDP growth at historical average minus one standard deviation in 2009-10 results in:
    - NPV of debt-to-GDP ratio increasing from 35 percent in 2008 to 41 percent in 2028.
    - NPV of Debt-to-Revenues-and-Grants ratio increasing from 215 to 250 percent.
    - Debt service-to-revenue ratio increasing from 17 to 23 percent.
  - Combined half-standard deviation shock to export growth, GDP deflator, and net non-debt creating flows causes NPV of debt-to-exports to peak near 300 percent in 2010 and remain above threshold for most of projection period.
- Staff conclusion
  - External debt dynamics subject to a moderate risk of distress.
  - Baseline does not indicate protracted breach of debt thresholds, but bound tests show potential protracted breaches.
  - Emphasis on implementing sound macroeconomic policies, raising real GDP growth, and achieving higher export growth; foreign financing at favorable terms—preferably grants—would help contain debt risks.

### Key macroeconomic projection assumptions and selected time-series figures (as presented)
- Real GDP growth (percent): 2006: 2.8; 2007: 2.5; 2008: 3.6; 2009: 1.7; 2010: 3.8; 2011: 4.5; 2012: 5.0; 2013: 5.5; 2018: 5.5; 2028: 5.5.
- GDP deflator in US dollar terms (change, percent): 2006: 17.5; 2007: 11.7; 2008: 4.0; 2009: 7.2; 2010: 14.2; 2011: 1.2; 2012: 3.5; 2013: 3.0; 2018: 2.1; 2028: 2.1.
- Effective interest rate (percent): 2006: 0.9; 2007: 0.9; 2008: 0.9; 2009: 0.1; 2010: 0.8; 2011: 0.9; 2012: 0.9; 2013: 0.9; 2018: 0.9; 2028: 1.0.
- Growth of exports of G&S (US$ terms, percent): 2006: 2.0; 2007: 10.8; 2008: -0.6; 2009: 12.4; 2010: 8.9; 2011: 7.2; 2012: 6.9; 2013: 8.9; 2018: 8.8; 2028: 7.1.
- Growth of imports of G&S (US$ terms, percent): 2006: 17.5; 2007: 13.9; 2008: 5.9; 2009: 14.4; 2010: 15.8; 2011: 12.7; 2012: 8.4; 2013: 8.5; 2018: 9.6; 2028: 7.7.
- Nominal GDP (billions of US$) (selected years): 2008: 8.9; 2010: 10.2; 2012: 12.1; 2014: 12.8; 2016: 13.9; 2018: 15.1; 2028: 17.6.

### World Bank and Asian Development Bank relations and support (selected points)
- World Bank partnership
  - PRS submission: July 2003; PRS objective to reduce poverty from about 40 percent to 30 percent by end of FY07.
  - FY08 lending activity: four projects approved for US$252.6 million; three more projects scheduled for Board presentation on May 6 for US$127 million (total FY08 lending US$379.6 million).
  - IDA portfolio (as of March 31, 2008): sixteen projects with total commitment of US$782.8 million and undisbursed balance of US$583 million.
  - Selected FY2008 IDA commitments preserved as in source (examples): PAF II — IDA 100.00; Undisb. 100.00; Irrigation & Water — IDA 50.00; Undisb. 50.00; Rural Road Sector Development — IDA 42.60; Undisb. 42.60.
  - Recent Economic and Sector Work includes: Nepal Development Policy Review (June 2004); Managing Public Finances for a New Nepal (June 2007).
- IFC activities
  - As of end January 2008, outstanding balance portfolio US$39.93 million in two power generation projects, one tourism project, and one leasing company.
  - FY07 GTFP participation: two Nepali banks signed for US$2 million each.
  - Advisory services include privatization/corporate advisory discussions and IFC-SEDF activities to increase SME access to financing.
- Asian Development Bank (AsDB)
  - As of 31 December 2007, cumulative lending to Nepal $2.25 billion, comprising 111 loans and six grant projects amounting to $183.9 million.
  - AsDB’s total country program for Nepal in 2008: $106.7 million (breakdown preserved as in source).
  - Undisbursed funds: $588 million (69 percent of total portfolio as of 31 December 2007).

### Staff appraisal, policy priorities, and recommended sequencing
- Maintain macroeconomic stability through budget discipline to preserve the peg and reserve position.
- Fiscal measures:
  - Limit domestic borrowing to 1-2 percent of GDP.
  - Cover NOC flow losses transparently; introduce automatic pricing mechanism for petroleum products.
  - Improve revenue collection and broaden Large Taxpayer Office reforms.
  - Modernize customs and public financial management; expand budget coverage beyond central budget.
- Monetary and financial sector measures:
  - Tighten monetary policy to reduce excess liquidity and negative real interest rates.
  - Strengthen supervision, enforcement, and licensing discipline; implement Basel II from July 2008.
  - Commercialize and complete restructuring of the two large public banks.
- Medium-term growth and external resilience:
  - Realizing peace dividend and developing hydropower could lift growth to 5−5½ percent over the medium term.
  - Seek concessional foreign financing—preferably grants—to support MDG progress while containing debt risks.
- Surveillance and programmatic follow-up:
  - Recommendation: next Article IV consultation on the 12-month cycle.

*Source: _cr08181 - 1. The Role of Remittances in Nepal’s Balance of Payments (IMF country report content provided).*

### 1. The Role of Remittances in Nepal’s Balance of Payments .................................................11

### 1. The Role of Remittances in Nepal’s Balance of Payments .................................................11

### Executive summary — background and vulnerabilities
- Despite civil conflict and political upheavals, macroeconomic performance in recent years has been stable:
  - Growth has been maintained albeit at low levels.
  - Inflation has remained stable.
  - The budget stance has been cautious.
  - Foreign exchange reserves are ample.
- Structural reform progress has been held back by the fragile political environment; vulnerabilities in the financial sector remain and could be growing:
  - Rapid credit growth, loose monetary conditions, and weak central bank supervision persist.
  - The losses of the state oil company are mounting.
- Unsettled political circumstances pose the most immediate risk to macroeconomic stability and growth; the demands of the peace process could result in pressures for greater public spending.

### Key macroeconomic findings and indicators
- Growth and inflation
  - Output growth has averaged 3 percent since 2002.
  - Outlook for 2007/08: staff projection of real GDP growth of 3½–4 percent; authorities argued growth could reach 4½ percent.
  - Inflation anchored by the exchange rate peg, projected to remain broadly stable around 6½ percent to 7 percent.
- External position and remittances
  - Foreign exchange reserves currently stand at $2 billion, or 6 months of imports.
  - Reserves of the central bank have doubled since 2002.
  - Workers’ remittances expected to grow by 20 percent over last year (2007/08 projection).
- Exchange rate and competitiveness
  - The real exchange rate has appreciated by 20 percent over the last three years, driven largely by the decline in the dollar against the Indian rupee.
  - With 70 percent of exports going to India, measured REER may overstate the impact on export competitiveness.
- Fiscal and public debt
  - Revenue growth has been strong, averaging 15 percent per year.
  - Public debt reduced to below 50 percent of GDP (driven by limited foreign borrowing and weakness of the U.S. dollar).
  - The budget deficit could rise this year to about 3½ percent of GDP, reflecting one-off election costs and clearance of most of Nepal Oil Corporation’s arrears.
  - Authorities aim to limit domestic borrowing in the next budget to a more sustainable level of 1-2 percent of GDP.
- Financial sector and monetary conditions
  - Loose monetary conditions have led to negative real interest rates, rapid and potentially destabilizing stock market and property price increases, and some capital flight to India.
  - Credit growth has been high, with many banks’ credit-to-deposit ratios pushed to levels above 100 percent.
  - Supervisory capability and regulatory compliance remain weak despite an overhauled legal framework.
- Public enterprises
  - Nepal Oil Corporation running an annualized deficit of about 1½ percent to 2 percent of GDP at current crude prices.

### Outlook and risks
- Growth prospects hinge on a peaceful political transition; with easing of constraints and development of hydropower, growth could lift to 5−5½ percent over the medium term.
- Immediate risks:
  - Fragile political environment, tension in the Terai, and potential pressures for greater public spending.
  - Slow structural reform progress during the political transition could undermine stability.

### Policy recommendations — fiscal and public sector
- Budget discipline is necessary to preserve macroeconomic stability and support the pegged exchange rate regime.
  - Staff urged limiting domestic borrowing to 1-2 percent of GDP in the next budget.
- Short-run priority: limit and eventually eliminate the losses of the state oil company.
  - Preferred option: introduce an automatic pricing mechanism to bring about phased convergence in domestic prices to world levels in a depoliticized manner.
  - In the meantime, staff urged that all the company’s flow losses be covered by the budget in a timely and transparent manner and any lending to the company be reflected in public debt.
- Further improvement in revenue collection is essential; broaden the progress of the Large Taxpayer Office to other areas of revenue administration.
- Accelerate reforms to increase accountability, transparency, and credibility of public expenditure:
  - Proposed measures include improving the coverage of financial information and the accounting system, developing a chart of accounts, and laying groundwork for establishing a treasury single account.
- Reduce reliance on domestic financing to avoid a growing interest bill that could threaten budget solvency.

### Policy recommendations — monetary, exchange rate, and financial sector
- Nepal’s peg to the Indian rupee continues to be appropriate in the near term; changing the rate or the regime is not recommended now.
- Authorities should take a more active role in reaching and maintaining a tighter monetary policy to address:
  - Negative real interest rates.
  - Rapid credit growth and potentially destabilizing asset price increases.
  - Some capital flight.
- Renewed impetus needed to strengthen supervision and regulatory enforcement to maintain financial stability amid rapid banking sector growth:
  - Legal framework improved but enforcement remains weak; supervisory forbearance and slow decision making are concerns.
  - Application of the stricter licensing requirements approved in April 2007 should be enforced; recent proliferation of licenses granted under the old regime undermines the policy signal.
- Reforms of the two large public banks need a clear forward strategy to make prior gains permanent; despite restructuring and loss reductions, the banks remain insolvent.

### Structural reforms and public financial management
- Limited progress in tax administration and public financial management:
  - Accounting, auditing, and reporting of public sector operations are inadequate.
  - Budget coverage confined to the central budget; about one-third of government expenditure occurs outside the budget in extrabudgetary funds and autonomous bodies.
  - Reforms needed to modernize customs, a significant source of revenue.
- Staff recommended donor- and Fund-supported technical assistance in key areas to strengthen fiscal monitoring and coordination of donor activity.

*Source: _cr08181 - 1. The Role of Remittances in Nepal’s Balance of Payments (IMF country report content provided).*

### 18.      The exchange rate peg to the Indian rupee has been instrumental in anchoring

### 18.      The exchange rate peg to the Indian rupee has been instrumental in anchoring

### Role of the peg and remittances
- The exchange rate peg to the Indian rupee, in place since 1993, has anchored inflation over the last several years and served Nepal well given close and increasing economic integration with India.
- Remittances are a major factor in balance of payments developments:
  - Workers’ remittances inflows are reported at over $1½ billion and are more important than exports as a source of foreign exchange.
  - Remittances have been described as transfers that in effect represent an export of labor services.
  - Trade balance combined with remittances is much more stable than the merchandise trade balance alone.
- Box 1 findings on remittances:
  - Nepal’s balance of payments has been in surplus for the last decade, with an annual reserve accumulation of around $150 million over the last five years.
  - Annual remittance flows now exceed 15 percent of GDP.
  - Migration patterns: about one million Nepalese are currently estimated to be working in India.
  - Remittances have boosted imports via higher consumption and demand for durable goods; concurrent export shocks (notably a decline in textiles) have deteriorated merchandise export performance.

### Assessment of exchange rate level and regime suitability
- Taking the balance of payments as a whole, the current level of the exchange rate appears broadly consistent with its equilibrium level.
- The overall external balance has been and remains in surplus, with the trade deficit largely offset by remittance inflows.
- Remittances are likely to persist and continue to provide a large sustainable source of inflows.
- In terms of the underlying savings-investment balance, a country at Nepal’s level of development should be running a modest current account deficit financed by official grants and loans (as it is at present).
- Attempts to offset recent real appreciation through a step devaluation are considered unlikely to be effective and could be quickly eroded by higher inflation via direct pass-through and increased domestic liquidity.
- Staff view:
  - Maintaining the peg to the Indian rupee would continue to be appropriate for Nepal’s macroeconomic stability and development in the near term.
  - Advantages of the peg: credible/simple nominal anchor, imports macro policy discipline from India, lowers business uncertainty and transaction costs, promotes integration with a fast-growing economy.
  - Advantages of a floating regime are fairly limited given Nepal’s institutional constraints; the NRB lacks the independence and discipline to successfully run an alternative anchor and keep inflation low.
  - Staff note potential future challenge: if productivity in India grows more rapidly than in Nepal, domestic factor market flexibility will be required to allow the real exchange rate to adjust; more flexible regimes (including a basket peg) could help smooth adjustment to further appreciation of the Indian rupee.
- Authorities’ position:
  - Authorities concurred on implications of higher productivity growth in India but are not considering alternatives to the existing pegged arrangement now.
  - They argued marginal benefits of moving away from the peg are outweighed by costs of regime change in the current political and economic environment.
  - They value the simplicity, predictability, and transparency of the peg and stressed the peg’s robustness via the possibility of parity changes when needed.
  - Staff agreed that now would not be the right time to change the rate or regime.

### Monetary policy, liquidity, and recommended actions
- Staff recommendation: tighten monetary conditions.
  - A relatively passive monetary policy has produced excess liquidity and negative real interest rates.
  - Loose monetary conditions have fueled a credit and asset price boom, and some capital flight.
  - Better liquidity management and forecasting is needed.
  - Separation of formulation and execution of monetary policy from public debt management is required.
  - The January temporary credit squeeze highlighted risks from highly uneven distribution of liquidity among banks in a shallow interbank market.
  - The NRB has tools to tighten monetary policy, including increased use of open market operations; authorities agreed in principle.

### Financial sector risks and reform recommendations
- Key concerns:
  - Rapid proliferation of financial institutions and credit growth coincided with sharp rises in stock market and property prices, increasing regulatory burden on the NRB.
  - Total assets of the banking system to GDP stood at 81 percent in July 2007.
  - Public banks account for about one third of banking sector assets.
  - Commercial banks increased from 17 to 23 in the last three years.
  - Deposit-taking nonbank financial institutions nearly doubled in 2007 to 139 institutions.
  - Credit growth around 25 percent system-wide; lending by private commercial banks at 36 percent.
  - System-wide average credit-to-deposit (CD) ratio increased from 60 percent over 2000–2006 to 78 percent by end-2007.
  - Nearly 25 percent of banking assets are held by smaller private banks with CD ratios exceeding 90 percent.
  - Nearly 60 percent of bank loans are secured by real estate assets.
  - Lending against stocks as collateral is about 3 percent of bank loan portfolios but has grown recently.
- Staff recommendations:
  - Strengthen supervision and regulatory enforcement; enforcement of the Banking and Financial Institutions Act once approved by parliament is crucial.
  - Take action against private banks violating capital adequacy requirements to protect regulatory credibility.
  - Pay particular attention to compliance with single-borrower limits and monitor indirect exposure to property and stock markets.
  - Welcome NRB directive to restrict margin lending using stocks as collateral.
  - Apply stricter licensing requirements approved in April 2007, including the “fit and proper” test, to signal enforcement willingness.
  - Continue movement toward risk-based supervision and implement Basel II beginning July 2008; encouraged further efforts.
  - Adopt a clear strategy to commercialize the two large public banks to bring them to solvency and ensure commercial operation; political consensus is currently lacking, with hoped progress after the April elections.
  - Improve debt collection enforcement (including via the Debt Recovery Tribunal) to shore up regulatory credibility; willful defaulters’ debts do not represent systemic risk but require action.

### Staff appraisal and policy priorities
- Recent achievements:
  - Nepal has maintained moderate inflation and budget discipline despite civil conflict and political upheavals.
- Critical juncture:
  - Continued stability is key to translating political transformation into higher, broad-based growth.
  - Address structural impediments (poor infrastructure, input supply disruptions) while maintaining budget discipline and banking sector soundness.
- Fiscal priorities:
  - Maintaining budget discipline is necessary for macroeconomic stability; further improvement in revenue collection remains a priority while increasing spending where needed.
  - Short-run priority: limit and eventually eliminate losses of the Nepal Oil Corporation.
    - Preferred permanent solution: introduction of an automatic pricing mechanism for petroleum products to depoliticize pricing.
    - All the company’s flow losses should be covered by the budget in a transparent manner going forward.
- Exchange rate conclusion reiterated:
  - Nepal’s peg to the Indian rupee has served the country well; maintaining it remains appropriate in the near term for macroeconomic stability and development.
  - With the overall balance in surplus and the reserve position strong and stable, there appears to be little sign of misalignment at present.
  - While a widening productivity gap with India could present challenges over time, now is not the right time to change the rate or the regime.

*Source: IMF staff report chapter on exchange rate regime, remittances, monetary policy, and financial sector (excerpts).*

### 34.      The authorities should take a more active role in reaching and maintaining a

### _cr08181 - 34.      The authorities should take a more active role in reaching and maintaining a

### Monetary policy and liquidity management
- The authorities should take a more active role in reaching and maintaining a tighter monetary policy.
- Rationale: an overall bias toward excess liquidity has led to negative real interest rates, rapid credit growth, potentially destabilizing asset price increases, and some capital flight.
- Recommendation: better liquidity management and forecasting is needed, and will require separation of the formulation and execution of monetary policy from public debt management.

### Financial supervision, regulation, and enforcement
- Renewed impetus should be given to strengthening supervision and regulatory enforcement to maintain financial stability in the face of rapid banking sector growth.
- Parliamentary approval of the Banking and Financial Institutions Act should further strengthen the regulatory framework, but significant improvements are needed in enforcement.
- Recommendation: the application of the stricter licensing requirements will be an important signal of the authorities’ willingness to tighten enforcement going forward.

### Public banks and commercialization
- A clear strategy is needed for completing the process of commercializing the two large public banks.
- Although progress has been made under new management teams in restructuring these banks, a strategy is needed for bringing them to solvency and ensuring that they will be operated on a commercial basis going forward.

### IMF surveillance cycle
- Recommendation: the next Article IV consultation should take place on the 12-month cycle.

### Selected relevant macroeconomic indicators (as presented)
- Real GDP at market prices (annual): 4.7; 3.1; 2.8; 2.5; 3.8
- CPI (12-month change): 2.0; 6.6; 8.3; 5.1; 7.0
- Total revenue (In percent of GDP): 11.3; 11.7; 10.9; 12.0; 13.5
- Total expenditure (In percent of GDP): 14.3; 14.9; 14.7; 15.7; 19.7
- Overall deficit after grants (In percent of GDP): 0.9; 0.8; 1.6; 1.4; 3.6
- Broad money (percent change): 12.8; 8.3; 15.4; 14.0; 18.0
- Private sector credit (percent change): 14.2; 12.9; 17.8; 12.1; 18.3
- Gross official reserves (end-of-period, in months of imports): 7.3; 6.4; 6.7; 6.5; 5.8
- External debt/GDP (percent): 46.1; 39.9; 39.1; 32.6; 29.1

*Source: IMF Staff Report for the 2008 Article IV Consultation—Informational Annexes (May 2, 2008).*

### ANNEX II.  NEPAL—RELATIONS WITH THE WORLD BANK GROUP

### ANNEX II.  NEPAL—RELATIONS WITH THE WORLD BANK GROUP

### I. Partnership in Nepal’s development strategy
- Reform momentum: Reform-minded officials began implementing reforms in earnest in late 2001, forming the basis for the first Immediate Action Plan (IAP) adopted in June 2002.
- 2003 Poverty Reduction Strategy (PRS):
  - Formal submission: PRS formally sent to the World Bank and IMF in July 2003.
  - Objective: Reduce the overall poverty ratio from about 40 percent to 30 percent by the end of FY07.
  - PRS pillars:
    - (i) achieving sustainable and broad-based economic growth with an emphasis on the rural economy;
    - (ii) accelerating human development through improved delivery of basic social services and economic infrastructure;
    - (iii) ensuring social and economic inclusion of the poor, marginalized groups and less developed regions;
    - (iv) pursuing good governance to achieve better development results, and ensure social and economic justice.
  - Progress: A PRS progress report by the National Planning Commission (NPC) prepared over a year ago notes that implementation of the PRS has been broadly satisfactory and measurable results are being achieved.
- Poverty trend cited: incidence of poverty fell from 42 percent (1995–96) to 31 percent (2003–04), with urban areas experiencing greater reductions than rural areas in the depth and severity of poverty.
- Engagement after April 10, 2008 elections: Bank preparing policy note presentations on key issues to present to the new government.

### II. IMF–World Bank collaboration in specific areas
A. Areas led by the Bank with no direct IMF involvement
- Social sectors:
  - Nepal Living Standards Survey II (NLSS II) TA (2003/04) updated household-level information on consumption, poverty, and determinants; NLSS II inputs used in PRS progress reports and Bank poverty report Nepal: Resilience Amidst Conflict—An Assessment of Poverty in Nepal, 1995–96 and 2003–04.
  - Education: IDA supports ten-year primary education reform via Education for All project (sector-wide approach “SWAp”) and Second Higher Education; IDA participates in pooled financing with Denmark, Finland, Norway, EC, ADB, UNICEF and the United Kingdom.
  - Community School Support Learning and Innovation Loan (LIL) to improve accountability and community management of primary schools.
  - Health: Bank supports devolution of sub-health posts and sector-wide reform; Health Sector Operation supports program; Avian Influenza Control Project operational.
- Infrastructure:
  - Power Development Project (PDP): develop hydropower potential, improve rural access, promote private sector participation.
  - Telecommunications Sector Reform Project: sector policy reforms and increased rural telecommunications through private operator introduction.
  - Road Sector Development Project: all-season road access in select hill districts.
- Rural development:
  - Nepal Irrigation and Water Resources Management Project: improve irrigated agriculture productivity and management; enhance institutional capacity.
  - Rural Access Improvement and Decentralization Project (RAIDP): improve governance and service delivery for rural infrastructure; promote agricultural and rural economic growth; generate employment via direct investments.
- Social inclusion:
  - Poverty Alleviation Fund (PAF I and II): channels resources to poorest groups; Bank financing supports implementation in 75 districts.
  - Social and gender analysis produced: Unequal Citizens: Gender, Caste and Ethnic Exclusion in Nepal.
- Environment:
  - Country Environmental Analysis completed in FY07; study underway on Adapting to Climate Change.

B. Areas where Bank leads and its analysis informs the IMF program
- Public expenditure analysis:
  - FY00 Public Expenditure Review (PER) supported public expenditure reform strategy and Medium Term Expenditure Framework (MTEF) introduced since FY04 to prioritize development budget.
  - Ongoing Bank AAA work: PER evaluating MTEF implementation; Public Finance Management (PFM) Review; Public Expenditure Financial Accountability (PEFA) assessment completed and established PFM benchmarks.
  - Government seeking WB cooperation to implement Action Plan to improve PFM.
- Public procurement and financial accountability:
  - Joint CPAR and CFAA conducted with Government.
  - Bank providing Institutional Development Fund (IDF) grants and TA for public expenditure management, decentralization, and financial accountability enhancement.
- Governance and anti-corruption:
  - Bank emphasized governance in 1998 and 2003 CASes; limited lending stance during FY99–FY02 (less than US$25 million per year) accompanied intensive dialogue.
  - IDF grants used to strengthen public sector institutions and implement policy recommendations.
  - Nepal selected as a pilot country for the Bank’s Governance and Anti-Corruption Plan (CGAC); Governance Assessment Note under preparation.
- Potential future support:
  - Development policy lending possibilities: (i) financing of a post-conflict program; (ii) supporting transition to more stable environment; (iii) supporting reform implementation.
  - Economic Reform Technical Assistance (ERTA) Project provides TA across PRS pillars.
  - Bank AAA emphasizes addressing challenges and bottlenecks to broad-based growth.

C. Areas of shared Bank–IMF responsibility
- PRS preparation and PRS Progress Reports: Bank and IMF (with other partners) provided assistance.
- Civil service reform: joint assistance via policy dialogue and TA toward autonomous, professional civil service and fiscal sustainability.
- Trade and competitiveness:
  - Bank-led Trade and Competitiveness Study identified constraints to integrating into multilateral trading system supportive of PRS; IMF assessed macroeconomic policy impacts and used study to design TA on tax policy including import tariffs for WTO accession.
- Financial sector reform:
  - Joint Bank–IMF focus to strengthen central bank authority and regulatory capacity, improve financial health and restructure two largest state banks, and upgrade legal/institutional framework.
  - Financial Sector Technical Assistance project supports: (i) restructuring/reengineering of the Central Bank; (ii) introduction of professional management teams into two large ailing commercial banks; (iii) capacity building for enhanced credit information; (iv) staff training upgrades.
  - Financial Sector Restructuring project supports further central bank strengthening and bank reform deepening.
  - FY05 Legal Financial Review completed.
  - Studies completed or underway: Access to Finance (microfinance financial performance and legal/regulatory obstacles); Technology in Microfinance (underway).
  - Investment Climate Assessment underway, to be completed in late FY09.

### III. World Bank Group strategy and lending operations
- Country Assistance Strategy (CAS):
  - November 2003 CAS presented; rationale for implementing a ‘base case’ lending program equivalent to approximately US$190 million annually.
  - Interim Strategy Note (ISN) presented February 2007; implementation note circulated August 2007.
  - New CAS planned for presentation in late FY09.
- FY08 lending activity:
  - In FY08 so far, four projects (one for additional financing) approved for US$252.6 million.
  - Three more projects scheduled for Board presentation on May 6 for another US$127 million, bringing total FY08 lending to US$379.6 million.
- IDA portfolio (as of March 31, 2008):
  - IDA’s lending portfolio: sixteen projects with a total commitment of US$782.8 million and a total undisbursed balance of US$583 million.
- Selected IDA project commitments and undisbursed balances (as presented in Table II.1; amounts preserved as in source):
  - FY2008: PAF II — IDA 100.00; Undisb. 100.00
  - FY2008: Irrigation & Water — IDA 50.00; Undisb. 50.00
  - FY2008: Rural Road Sector Development — IDA 42.60; Undisb. 42.60
  - FY2008: Education For All Additional Financing — IDA 60.00; Undisb. 60.00
  - FY2007: Second Higher Education — IDA 60.00; Undisb. 60.00
  - FY2007: Avian Influenza Control — IDA 18.20; Undisb. 17.00
  - FY2005: Education for All Project — IDA 110.00; Undisb. 72.30
  - FY2005: NP. Economic Reform TA — IDA 3.00; Undisb. 1.60
  - FY2005: Nepal Health Sector Program Project — IDA 50.00; Undisb. 18.20
  - FY2005: Rural Access Improve. & Decentralization — IDA 32.00; Undisb. 27.30
  - FY2004: NP Fin Sector Restructuring (Phase II) — IDA 75.50; Undisb. 20.50
  - FY2004: Poverty Alleviation Fund — IDA 40.00; Undisb. 15.90
  - FY2004: Rural Water Supply & Sanitation Project — IDA 25.30; Undisb. 8.70
  - FY2003: NP Financial Sector Technical Assistance — IDA 16.00; Undisb. 7.90
  - FY2003: POWER DEVELOPMENT PROJECT — IDA 74.80; Undisb. 68.60
  - FY2003: Community School Support Project — IDA 5.00; Undisb. 3.77
  - FY2002: NP: Telecommunications Sector Reform — IDA 20.40; Undisb. 8.70
  - Table totals: Total IDA commitments US$782.80; Total undisbursed US$583.07

- Economic and Sector Work (recently completed):
  - Nepal Development Policy Review: Restarting Growth and Poverty Reduction (June 2004)
  - Unequal Citizens: Gender, Caste and Ethnic Exclusion in Nepal (June 2005)
  - Nepal Decentralized Organizations Study (March 2004)
  - Urbanization and Service Delivery in the Context of Decentralization: A Review of the Issues for the Kathmandu Valley (December 2004)
  - Legal Financial Review (February 2005)
  - North South Transport Corridor Options (August 2004)
  - Nepal: Resilience Amidst Conflict: An Assessment of Poverty in Nepal, 1995–96 and 2003–04 (June 2006)
  - Managing Public Finances for a New Nepal (June 2007)

A. Activities of the International Finance Corporation (IFC) in Nepal
- Investment Services:
  - As of end January 2008, IFC’s outstanding balance portfolio in Nepal is US$39.93 million in two power generation projects, one tourism project, and one leasing company.
  - FY07 GTFP participation: IFC signed two Nepali banks, Bank of Kathmandu and Nepal Industrial and Commercial Bank, to the Global Trade Finance Program (US$2 million each).
  - Discussions with Himalayan Bank for GTFP participation.
  - IFC considering equity investments with Bank of Kathmandu and Himalayan Bank.
  - With improving security/peace process, IFC exploring new investment opportunities in cement, hydropower and the financial sector.
- Advisory Services:
  - Privatization/corporate advisory discussions initiated for possible privatization/restructuring of Nepal Airlines and Nepal Telecom.
  - IFC-SEDF (Dhaka-based South Asia Enterprise Development Facility) delivers TA to increase SME access to financing and business development services and develop linkages with larger enterprises; funded in partnership with Canada, Netherlands, Norway, the United Kingdom, Asian Development Bank, and the European Union.
  - Access to Finance: IFC-SEDF signed Partner Financial Institution MOUs with Himalayan Bank and Bank of Katmandu; diagnostics and road-maps for institutional capacity building underway; diagnostic of NIC Bank scheduled for mid-June.
  - Future advisory work: Credit Bureau Strengthening Project to make newly privatized Credit Bureaus commercially viable; development of SME banking products and institutional capacity building; assist banks in transitioning to more industrialized banking with standardized products, streamlined processes, and effective use of technologies.
  - Business enabling environment: IFC-SEDF and FIAS reviewed draft Special Economic Zone (SEZ) legislation (September 2006) and conducted Investment Climate Mini Diagnostic (February–March 2007) identifying constraints: rigid labor regulations, inefficient customs administration, non-transparent and inconsistent tax administration, inappropriate licensing and certification regimes, lack of inspections capacity, and barriers to exit.
  - Proposed Nepal Investment Climate Reform Program (NICRP): developing a four year US$6 million program focused on helping SEZs meet international best practice.

*Source: ANNEX II.  NEPAL—RELATIONS WITH THE WORLD BANK GROUP (As of April 30, 2008).*

### ANNEX III.  NEPAL—RELATIONS WITH THE ASIAN DEVELOPMENT BANK

### ANNEX III.  NEPAL—RELATIONS WITH THE ASIAN DEVELOPMENT BANK

### Country Program
- As of 31 December 2007, cumulative lending to Nepal was $2.25 billion, comprising 111 loans and six grant projects amounting to $183.9 million.
- Sectors covered through AsDB loans and grants: agriculture and natural resources, education, energy, finance, industry and trade, law, economic management and public policy, transport and communication, and water supply, sanitation, and waste management.
- AsDB’s total country program for Nepal in 2008 amounts to $106.7 million, comprising:
  - Education Sector Cluster Program ($8 million, subprogram 2)
  - Information and Communications Development Project ($25 million)
  - Power Sector Development Project I ($30 million)
  - Local Governance and Community Development Support Program I ($43.7 million)
- Undisbursed funds of $588 million represent 69 percent of the total portfolio amount as of 31 December 2007.

### Loans and Grants (1969–2007; as of 31 December 2007)
- Total approved (loan and grant) by year (in millions of U.S. dollars):
  - 1968–2000: 1,806.13
  - 2001: 95.6
  - 2002: 60
  - 2003: 94
  - 2004: 110
  - 2005: 0
  - 2006: 169.9
  - 2007: 100
- Gross disbursements by year (in millions of U.S. dollars):
  - 1968–2000: 1,220.60
  - 2001: 57.3
  - 2002: 28.2
  - 2003: 33.5
  - 2004: 22
  - 2005: 43.7
  - 2006: 108.0
  - 2007: 102.3
- Loans by sector (cumulative and by year where shown; in millions of U.S. dollars):
  - Agriculture and natural resources: 656.23 (1968–2000); 0 (2001); 0 (2002); 20 (2003); 70 (2004); 0 (2005); 0 (2006); 0 (2007)
  - Education: 61.1 (1968–2000); 19.6 (2001); 30 (2002); 0 (2003); 20 (2004); 0 (2005); 30 (2006); 0 (2007)
  - Energy: 364.4 (1968–2000); 0 (2001); 0 (2002); 0 (2003); 0 (2004); 0 (2005); 0 (2006); 0 (2007)
  - Finance: 7.3 (1968–2000); 0 (2001); 0 (2002); 0 (2003); 0 (2004); 0 (2005); 56 (2006); 0 (2007)
  - Industry and trade: 129.18 (1968–2000); 0 (2001); 0 (2002); 0 (2003); 0 (2004); 0 (2005); 0 (2006); 0 (2007)
  - Law, economic and public policy: 30 (1968–2000); 35 (2001); 0 (2002); 0 (2003); 0 (2004); 0 (2005)
  - Transport and communication: 236.86 (1968–2000); 46 (2001); 0 (2002); 0 (2003); 20 (2004); 0 (2005); 0 (2006); 0 (2007)
  - Water supply, sanitation and waste management: 224 (1968–2000); 0 (2001); 0 (2002); 39 (2003); 0 (2004); 0 (2005); 0 (2006); 0 (2007)
  - Multisector: 127.06 (1968–2000); 0 (2001); 30 (2002); 0 (2003); 0 (2004); 0 (2005); 0 (2006); 0 (2007)
- Grants by sector (selected values shown in source; in millions of U.S. dollars):
  - Agriculture and natural resources: 18
  - Education: 2
  - Finance: 8.7
  - Transport and communication: 55.2
  - Multisector: 100
  - Total grants: 83.9 (year unspecified in table) and 100 (year unspecified in table)

### Technical Assistance
- Since 1968, AsDB has provided Nepal with technical assistance in most sectors.
- As of 31 December 2007, ADB approved 270 technical assistance projects totaling $127.8 million.
- There are currently 33 ongoing TAs, including 2 JFPR projects.

### Private Sector Operations
- Strategic objective: develop a strong and dynamic private sector through infrastructure investments and policy/legal environment improvements supported by public sector lending and technical assistance.
- Cumulative approvals for private sector projects in Nepal at end-2007: $58.64 million (for 4 projects).
- ADB’s outstanding exposure to non-sovereign projects totaled $24.4 million, representing 1.4 percent of ADB’s total non-sovereign portfolio.
- Current consideration: AsDB is looking into the possibility of financing the proposed 750 MW West Seti Hydropower project.

*Source: _cr08181 - ANNEX III. NEPAL—RELATIONS WITH THE ASIAN DEVELOPMENT BANK (As of 31 December 2007).*

### 3.      A key feature of the LIC−DSA framework is that it compares debt burden

### 3.      A key feature of the LIC−DSA framework is that it compares debt burden indicators to indicative policy-based thresholds.

### Framework and country classification
- The LIC−DSA framework compares debt burden indicators to indicative policy-based thresholds.
- Thresholds are based on the empirical finding that low-income countries with stronger policies and institutions tend to have a higher debt carrying capacity.
- Nepal is classified as a medium performer based on its three year average CPIA score during 2004-06.

### External debt burden indicators and thresholds
- At end-2007, Nepal’s NPV of public debt-to-exports ratio is estimated at 148 percent (the relevant policy based indicative threshold is 150 percent).
- The NPV of public debt-to-exports ratio is projected to fall to 87 percent by 2027/28.
- Other indicators remain below the policy-based indicative thresholds throughout the projection period.

### Baseline projections (2007/08–2027/28)
- In the baseline scenario, debt burden ratios are projected to fall between 2007/08 and 2027/28.
- Key projected changes:
  - NPV of external public debt-to-GDP: decline from 20 percent to around 12 percent.
  - NPV of external public debt-to-exports: fall from 148 percent to 87 percent.
  - External public debt service-to-exports ratio: decline from 9 percent to 6 percent.

- Table-like figures preserved from source (labels preserved as in source):
  - NPV of debt, in percent of
    - Exports150148116
    - GDP402215
    - Revenue250163114
  - Debt Service, in percent of
    - Exports20117
    - Revenues30126
  - Indicative Thresholds
  - Nepal: projected average 2007/08-2027/28
  - Nepal: Indicative External Debt Burden Indicators
  - Nepal: 2006/07
  - Total Public Debt

### Public debt composition and public-debt projections
- Domestic debt accounts for about 30 percent of total public debt at end-2007.
- For the baseline scenario, NPV of public debt-to-GDP ratio:
  - Declines from 35 percent at end 2007/08 to 26 percent by 2027/28.
- Over the same period:
  - NPV of public debt-to-revenue ratio falls from 216 percent to 157 percent.
  - Public debt service-to-revenue ratio decreases from 17 percent to 12 percent.

### Context for baseline projections
- The projected increase in fiscal spending in 2007/08 is driven mainly by pre-election and election spending, higher costs associated with clearing Nepal Oil Corporation’s arrears, and increased donor flows.
- The baseline projections expect the current account, which has been historically a surplus in Nepal, to unwind gradually into a deficit, as spending and higher growth result in more imports of goods and services and the surge in remittances stabilizes.
- The average current account deficit over the projection period 2008-28 is a little over 1 percent of GDP relative to the historical average of a surplus current account of 3.4 percent.
- A historical scenario where the current account surplus of 3.4 percent of GDP continues into the projection period suggests negative borrowing and thereby steady declines in debt; in view of this, debt is constrained to zero in 2018.
- Given the high concessionality of external debt, the debt service-to-exports ratio is low, and at levels similar or lower than to most HIPCs after full HIPC debt relief. The ratio reflects debt service on existing debt and debt service on projected disbursements.

### Sensitivity analysis and stress tests
- Stress tests and alternative scenarios suggest vulnerability to shocks.
- Total public debt shocks:
  - A shock modeled as real GDP growth at historical average minus one standard deviations in 2009-10 results in:
    - NPV of debt-to-GDP ratio increasing from 35 percent in 2008 to 41 percent in 2028.
    - NPV of Debt-to-Revenues-and-Grants ratio increasing from 215 to 250 percent.
    - Debt service-to-revenue ratio increasing from 17 to 23 percent.
  - Alternative scenarios maintaining the 2008 fiscal stance (primary balance) could result in NPV of debt-to-GDP ratio increasing from 35 in 2008 to 44 percent in 2028.
  - This scenario illustrates the importance of the peace dividend as reflected in stronger real GDP growth.
- External debt bound tests:
  - A combined, half-standard deviation shock to export growth, GDP deflator, and net non-debt creating flows causes the NPV of debt-to-exports ratio to increase significantly, peaking at near 300 percent in 2010, and staying above the threshold for most of the projection period.
  - Other bound tests (e.g. shocks to exports and non-debt creating flows) also cause the NPV of debt-to-exports to break the thresholds.
  - These results are partly driven by Nepal’s volatile export performance in the past decade.
  - Shocks to other debt indicators such as the NPV of debt-to-GDP and debt service-to-revenue result in trajectories below threshold values.

*Source: IMF staff report excerpt provided in the content unit.*

### 7.      Based on the LIC-DSA, staffs conclude that Nepal’s external debt dynamics are

### _cr08181 - 7.      Based on the LIC-DSA, staffs conclude that Nepal’s external debt dynamics are

### External debt assessment
- Staffs conclude that Nepal’s external debt dynamics are subject to a moderate risk of distress.
- Since the last DSA in 2007, the initial net present value of debt has improved due to the appreciation of the Nepalese rupee and lower than projected loan disbursements in the interim.
- The baseline scenario does not indicate a protracted breach of debt thresholds, in contrast to the previous DSA.
- Bound tests reflecting shocks to export growth and non-debt creating flows could result in protracted breach of the debt thresholds.
- Sensitivity analyses underscore the need to implement sound macroeconomic policies and reforms, including through raising the real GDP growth rate and achieving higher export growth.
- Stronger and more stable growth in exports contributing to higher GDP growth, combined with foreign financing at favorable terms—preferably through grants—would help Nepal make progress toward achieving its MDG targets while containing risks to debt sustainability.

### Key statistics (selected exact figures from staff tables and projections)
- External debt (nominal) 2006: 37.9; 2007: 35.5; 2008: 29.1; 2013: 26.5; 2018: 24.6; 2028: 20.7 (in percent of GDP, unless otherwise indicated).
- o/w public and publicly guaranteed (PPG) 2006: 35.3; 2007: 33.0; 2008: 26.9; 2013: 24.1; 2018: 22.1; 2028: 18.0.
- Change in external debt (selected years): 2008: -6.3; 2009: -0.4; 2010: -1.0; 2013: -0.1; 2018: -0.6; 2028: -0.3.
- Identified net debt-creating flows (selected years): 2008: -1.9; 2009: -2.5; 2010: -2.0; 2013: -0.7; 2018: -0.4; 2028: 0.3.
- Non-interest current account deficit (selected years): 2008: -3.4; 2009: 1.4; 2010: -0.9; 2013: -0.5; 2018: 0.2; 2028: 0.8.
- Deficit in balance of goods and services (selected years): 2006: 18.1; 2007: 18.4; 2008: 18.7; 2010: 20.6; 2013: 21.1; 2018: 20.1; 2028: 17.9.
- Exports (percent of GDP, selected years): 2006: 13.6; 2007: 13.2; 2008: 12.1; 2013: 12.1; 2018: 12.1; 2028: 13.3.
- Imports (percent of GDP, selected years): 2006: 31.7; 2007: 31.6; 2008: 30.8; 2013: 33.3; 2018: 32.2; 2028: 31.2.
- Net current transfers (negative = inflow) (selected years): 2006: -19.5; 2007: -17.9; 2008: -15.7; 2013: -19.8; 2018: -19.6; 2028: -19.2.
- Endogenous debt dynamics (selected years): 2008: -0.9; 2009: -1.0; 2010: -1.1; 2013: -1.1; 2018: -1.0; 2028: -0.9.
- Contribution from nominal interest rate (selected years): 2008: 0.3; 2009: 0.3; 2010: 0.3; 2013: 0.2; 2018: 0.3; 2028: 0.2.
- Contribution from real GDP growth (selected years): 2008: -1.0; 2009: -0.8; 2010: -1.1; 2013: -1.4; 2018: -1.3; 2028: -1.1.
- Residual (3-4) (selected years): 2008: -4.4; 2009: 2.1; 2010: 1.0; 2013: 0.5; 2018: -0.2; 2028: -0.6.
- NPV of external debt (selected years): 2008: 22.1; 2009: 19.4; 2010: 19.3; 2013: 18.0; 2018: 16.9; 2028: 14.3.
- NPV of external debt in percent of exports (selected years): 2008: 167.3; 2009: 160.4; 2010: 157.6; 2013: 148.4; 2018: 139.9; 2028: 107.6.
- NPV of PPG external debt (selected years): 2008: 19.6; 2009: 17.1; 2010: 17.0; 2013: 15.6; 2018: 14.5; 2028: 11.6.
- PPG debt service-to-exports ratio (in percent) (selected years): 2008: 13.8; 2009: 10.8; 2010: 9.2; 2013: 8.6; 2018: 7.9; 2028: 5.5.
- PPG debt service-to-revenue ratio (in percent) (selected years): 2008: 17.2; 2009: 11.9; 2010: 8.2; 2013: 7.4; 2018: 6.4; 2028: 5.0.
- Total gross financing need (billions of U.S. dollars) (selected years): 2008: 0.2; 2009: 0.3; 2010: 0.3; 2013: 0.7; 2018: 1.0; 2028: 2.2.
- Non-interest current account deficit that stabilizes debt ratio (selected years): 2008: 4.6; 2009: 1.6; 2010: 5.4; 2013: 0.6; 2018: 1.7; 2028: 2.5.

### Key macroeconomic assumptions (exact values used in projections)
- Real GDP growth (in percent) historical and projections: 2006: 2.8; 2007: 2.5; 2008: 3.6; 2009: 1.7; 2010: 3.8; 2011: 4.5; 2012: 5.0; 2013: 5.5; 2018: 5.5; 2028: 5.5; 2014-28 Average: 5.0; (other projections repeated as 5.5 where specified).
- GDP deflator in US dollar terms (change in percent) (selected years): 2006: 17.5; 2007: 11.7; 2008: 4.0; 2009: 7.2; 2010: 14.2; 2011: 1.2; 2012: 3.5; 2013: 3.0; 2018: 2.1; 2028: 2.1.
- Effective interest rate (percent) 2006: 0.9; 2007: 0.9; 2008: 0.9; 2009: 0.1; 2010: 0.8; 2011: 0.9; 2012: 0.9; 2013: 0.9; 2018: 0.9; 2028: 1.0.
- Growth of exports of G&S (US dollar terms, in percent) (selected years): 2006: 2.0; 2007: 10.8; 2008: -0.6; 2009: 12.4; 2010: 8.9; 2011: 7.2; 2012: 6.9; 2013: 8.9; 2018: 8.8; 2028: 7.1.
- Growth of imports of G&S (US dollar terms, in percent) (selected years): 2006: 17.5; 2007: 13.9; 2008: 5.9; 2009: 14.4; 2010: 15.8; 2011: 12.7; 2012: 8.4; 2013: 8.5; 2018: 9.6; 2028: 7.7.
- Grant element of new public sector borrowing (in percent) (selected years): 2011: 47.0; 2012: 46.8; 2013: 46.7; 2018: 45.9; 2028: 45.7.
- Memorandum: Nominal GDP (billions of US dollars) (selected years): 2008: 8.9; 2010: 10.2; 2012: 12.1; 2014: 12.8; 2016: 13.9; 2018: 15.1; 2028: 17.6; (final listed: 25.1; 48.3 in table footnote context).

### Sensitivity analyses and scenarios (selected outcomes preserved exactly)
- Alternative scenarios and bound tests indicate stress outcomes that, in some tests, raise indicators substantially:
  - A2 (New public sector loans on less favorable terms in 2009-28) shows higher NPV ratios (examples in table: 1718... etc. as presented in staff tables).
  - Bound test B4 (Net non-debt creating flows at historical average minus one standard deviation in 2009-10) yields elevated ratios in several indicators (tables show sequences such as 1722252424242114 and related series).
  - One-time 30 percent nominal depreciation relative to the baseline in 2009 (B6) is included as a stress test and produces higher indicator paths in staff simulations.
- Table 2 and accompanying figures present multiple scenario series for NPV of debt-to-GDP ratio, NPV of debt-to-exports ratio, and NPV of debt-to-revenue ratio, including baseline, historical-scenario, most extreme shock, and other alternatives (exact series values are presented in staff tables and figures).

### Public sector debt dynamics and fiscal indicators (selected exact figures)
- Public sector debt (percent of GDP) 2006: 56.7; 2007: 46.7; 2008: 44.6; 2013: 38.8; 2018: 33.6; 2028: 32.5.
- o/w foreign-currency denominated public debt (percent of GDP) 2006: 35.3; 2007: 33.0; 2008: 26.9; 2013: 23.6; 2018: 21.7; 2028: 17.7.
- Change in public sector debt (selected years): 2008: -2.1; 2009: -0.3; 2010: -1.3; 2013: -1.5; 2018: -0.7; 2028: 0.1.
- Identified debt-creating flows (public sector) (selected years): 2008: -0.2; 2009: -0.6; 2010: -1.7; 2013: -2.3; 2018: -0.2; 2028: 0.6.
- Primary deficit (selected years): 2008: 1.5; 2009: 1.5; 2010: 2.6; 2013: 0.7; 2018: 0.5; 2028: 0.1.
- Revenue and grants (percent of GDP, selected years): 2006: 13.1; 2007: 14.3; 2008: 16.1; 2013: 18.0; 2018: 16.8; 2028: 16.4.
- Primary (noninterest) expenditure (percent of GDP, selected years): 2006: 13.8; 2007: 14.8; 2008: 18.8; 2013: 18.1; 2018: 18.2; 2028: 18.3.
- Automatic debt dynamics (selected years): 2008: -2.9; 2009: -2.0; 2010: -2.7; 2013: -2.5; 2018: -1.6; 2028: -1.3.
- NPV of public sector debt (selected years): 2006: 43.9; 2007: 33.3; 2008: 34.9; 2013: 30.8; 2018: 26.3; 2028: 26.4.
- Gross financing need (selected years): 2006: 3.9; 2007: 3.7; 2008: 5.4; 2013: 2.5; 2018: 3.5; 2028: 3.9.
- NPV of public sector debt-to-revenue and grants ratio (in percent) (selected years): 2006: 335.0; 2007: 233.3; 2008: 216.2; 2013: 171.3; 2018: 156.6; 2028: 161.0.
- Debt service-to-revenue and grants ratio (in percent) (selected years): 2006: 24.1; 2007: 22.3; 2008: 17.5; 2013: 13.3; 2018: 12.3; 2028: 12.2.
- Primary deficit that stabilizes the debt-to-GDP ratio (selected years): 2008: 4.7; 2009: 1.7; 2010: 2.3; 2013: 1.6; 2018: 2.0; 2028: 1.8.

### Policy recommendations and priorities (as stated by staff and Executive Directors)
- Implement sound macroeconomic policies and reforms to raise real GDP growth and achieve higher export growth.
- Seek stronger and more stable export growth and foreign financing at favorable terms—preferably through grants—to support MDG progress while containing debt sustainability risks.
- Limit—and eventually eliminate—the losses of the Nepal Oil Corporation; consider introducing an automatic pricing mechanism for petroleum products to depoliticize price setting.
- Pursue more active monetary policy and a reduction of the liquidity bias that has led to negative real interest rates and rapid credit growth.
- Improve liquidity management and forecasting, and separate the formulation and execution of monetary policy from public debt management.
- Strengthen financial sector supervision, regulatory enforcement, and apply stricter licensing requirements; complete restructuring and commercialization of the two large public banks.
- Continue efforts to improve tax administration and public financial management, including accounting, auditing, and reporting of public sector operations and broader budget coverage.

*Source: Staff simulations, projections, and IMF Executive Board assessment as presented in the provided document._cr08181 - 7.      Based on the LIC-DSA, staffs conclude that Nepal’s external debt dynamics are*

### 1.             On behalf of the Nepalese authorities, we wish to express our sincere gratitude and

### On behalf of the Nepalese authorities, we wish to express our sincere gratitude and

### Recent Political Developments
- Constituent Assembly (CA) election held on April 10, 2008.
- The historic People’s Movement of April 2006 ended the decade-long civil conflict.
- CA election was part of the comprehensive peace agreement (CPA) among the seven-party alliance (SPA); the Maoist party emerged as the largest party in the CA, with a simple majority.
- First meeting of CA slated within 21 days of the final announcement of the CA election results.
- Political parties committed to the peace process and to accelerating economic growth by improving the investment climate and initiating necessary reforms.

### Macroeconomic Developments
- Under the PRGF-supported program, annual economic growth averaged 3.4 percent.
- Real GDP growth: 2.8 percent in 2005/06 and 2.5 percent in 2006/07.
- Deceleration in 2006/07 attributed largely to adverse weather conditions and political-transition-related impediments.
- Consumer price-based inflation averaged 5.5 percent over the last five years.
- Inflation rates: 8 percent in 2005/06 and 6.4 percent in 2006/07, attributed to rises in energy prices and food prices.
- Overall balance of payments (BOP) remained in surplus, driven mainly by elevated workers' remittances.
- Recent remittance growth accelerated; official international reserves as of mid-March 2008 stood at US$ 2.2 billion, sufficient to cover 7.1 months' imports of goods and services.

### Macroeconomic Outlook
- Authorities expect growth in 2007/08 to be on the upper end of staff's projection of 3.5–4 percent, compared to 2.5 percent in 2006/07.
- Growth drivers for 2007/08: satisfactory agriculture growth, encouraging increase in tourist arrivals, and some improvements in services; merchandise exports and manufacturing expected to perform weaker.
- Expectations that improvements in the investment climate and continuation of structural reforms will support more robust medium-term performance.
- Authorities expect inflation to stabilize at around 7 percent in 2007/08, with inflationary pressures from higher energy, commodities and food prices; overdue adjustment in oil prices noted as having greatest impact on headline inflation.
- On external front: trade deficit expected to widen as merchandise imports grow faster than exports; workers’ remittances expected to sustain recent growth of 28 percent, likely more than offsetting the trade deficit and leading to a modest surplus in the BOP.

### Fiscal Policy
- Net fiscal deficit in 2006/07: 1.4 percent of GDP, reflecting pickup in revenue growth and controlled government spending.
- Net domestic financing of budget deficit in 2006/07: 0.9 percent of GDP.
- Government finance data as of May 2, 2008 show significant cumulative cash balances maintained by the government with the NRB.
- Revenue growth showing 25.3 percent; government’s domestic borrowing expected to remain within budgeted limit.
- Risks to fiscal balance: rising public expectations for rehabilitation, relief measures and infrastructure reconstruction; persistent losses from Nepal Oil Corporation (NOC).
- Government extended loans of 4 billion rupees to NOC in the current fiscal year to help maintain domestic petroleum supply.
- Authorities consider oil-sector reform a key policy challenge; a recent upward price adjustment attempt was aborted due to public protest.

### Monetary and Exchange Rate Policy
- Authorities concur with staff that Nepalese real exchange rate is in line with fundamentals and supports external stability.
- Public debt-to-GDP ratio declined from 61.7 percent in 2002/03 to 43.9 percent in 2006/07.
- Total foreign debt declined from 45.4 percent of GDP in 2002/03 to 30.1 percent in 2006/07.
- Nominal appreciation of Nepalese rupee (NC) against U.S. dollar noted, driven by appreciation of Indian Currency (IC) vis-à-vis U.S. dollar; authorities agree with staff that this is not the appropriate time to change exchange rate level or regime.
- Monetary growth exceeded initial projections; new banks and increased competition led to uneven distribution of liquidity.
- NRB interventions: directive on margin lending issued on January 22, 2008 to banks and financial institutions to manage margin lending and ensure orderly stock market development.
- NRB focuses on open market operations using outright sale auctions, outright purchase auctions, repo auctions and reverse repo auctions; liquidity monitoring and forecasting framework (LMFF) based on weekly NRB balance sheet guides operations.
- Banking sector liquidity monitored daily; authorities committed to modulate liquidity through appropriate policy actions.

### Structural Reforms
- Structural reforms undertaken in government finances, public enterprises and financial sector during PRGF program period.
- Fiscal sector reforms include establishment of a large tax office (LTO), wide area network (WAN) between headquarters and regional customs offices, and expansion of the ASYCUDA system.
- New custom act enacted in September 2007 with reforms: improved valuation system according to GATT principles, provision for offsite declaration and clearance, declaration before arrival of goods, provision of import return on re-export, special provision for Special Economic Zone (SEZ), post clearance audit, and risk-based audit.
- Measures to increase fiscal transparency and accountability include creation of CIAA, National Vigilance Centre (NVC), published guidance for taxpayers, public hearings in tax and customs administrations, reclassification of expenditures into recurrent and capital, formulation and implementation of budget in line with MTEF, publication of annual and mid-term budget reviews, and publication of financial performance of public enterprises.
- Financial sector measures: NRB doubled minimum paid-up capital for new banks and financial institutions in April 2007; fit and proper tests for promoters, boards and CEOs issued.
- Directive to divest promoter shares in other banks and financial institutions by mid-July 2008 to remove distortions from cross-lending of shares.
- Directive on prompt corrective actions effective from October 16, 2008.
- Cabinet approved revised draft of the Banks and Financial Institutions Act (BAFIA) incorporating 25 core principles of bank supervision and clear guidelines for mergers, acquisitions and liquidation procedures.
- NRB announced parallel implementation of Basel II for current fiscal year with trial reporting initiated; target to move to a Basel II framework by July 2008.
- Bank restructuring: operational and financial restructuring of the two largest public banks under a World Bank FSRP; during five-year restructuring, banks registered operational profits, significant reduction in NPAs, and 80 percent of banks’ operations computerized.
- Authorities propose continuing restructuring for an additional three years, to be carried out by local professional bankers under NRB control with World Bank concurrence.
- In energy sector, authorities made two upward revisions in petroleum prices during the year; consider introducing an automatic pricing mechanism and private-sector participation in importation and distribution of oil.

### Conclusion
- Nepal’s macroeconomic performance remains stable; authorities acknowledge the role of the PRGF program in maintaining stability under difficult political conditions.
- Authorities committed to safeguarding macroeconomic stability and solicit donor community support to advance sustainable peace and stable economic growth.
- A successor to the PRGF program is viewed as playing a key role in anchoring overall macroeconomic policy going forward.
- Authorities have consented to the publication of the staff report.

*On behalf of the Nepalese authorities.*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08181.pdf_