## IMF Country Report _cr15317 (Nepal) — Excerpts

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---

### Recent developments and earthquake impacts
- Two massive earthquakes in April and May resulted in:
  - Over 8,800 lives lost.
  - Damages and losses estimated at US$7 billion or nearly one third of GDP.
  - Multilateral and bilateral donors pledged more than US$4 billion in grants and concessional loans to be disbursed over five years (pledged at June 25 donor conference).
  - The authorities requested the equivalent of SDR35.65 million (50 percent of quota) under the Fund’s Rapid Credit Facility; the funds were disbursed as direct budget support.
- Political disruptions after September 20 promulgation of the constitution:
  - Triggered unrest, a fuel crisis, and a change in government.
  - Disruptions to transportation and trade routes to/from the southern border caused shortages of fuel and other imported goods.
  - Parliament voted out the Prime Minister; a new Prime Minister and Cabinet were inaugurated in mid-October.

### Macroeconomic status and recent performance
- Structural context and key indicators:
  - Poverty declined from over 50 percent in 2003/04 to just under 25 percent in 2010/11.
  - Remittances currently amount to about 29 percent of GDP.
- 2014/15 outturns and near-term status:
  - Real GDP growth: 3.4 percent in 2014/15 (pre-earthquake baseline forecast was 5 percent); growth had been 5.5 percent in 2013/14 and averaged 4 percent in the three previous years.
  - Inflation: accelerated to 6.9 percent in August (y/y).
  - Government spending: preliminary data suggest a 28 percent increase in capital spending in 2014/15.
  - Fiscal position: budget recorded a surplus (third year in a row) despite revenues falling short of the budget for the first time in several years.
  - Public debt: fell to 26 percent of GDP in 2014/15 from 32 percent of GDP in 2012/13.
  - External sector: current account surplus of 5.0 percent of GDP in 2014/15, aided by a surge in remittances and lower oil import prices.
  - Reserves: US$7.2 billion, or 33 percent of GDP, covering almost eight months of prospective imports.
  - Financial system: as of July 2015, commercial and development banks had capital adequacy ratios comfortably in excess of the required minima (6 percent) and reported low non-performing loans.

### Outlook and risks
- Staff projections:
  - Growth is expected to rebound gradually to around 5½ percent by 2016/17 as reconstruction gains momentum.
  - Inflation is projected to rise to about 8½ percent over the next 12 months.
  - Reconstruction-related foreign aid and higher remittances will boost liquidity pressures, requiring active liquidity management to avoid excess inflation relative to India.
- Scenario dependence:
  - Baseline: donor-funded reconstruction rebound; growth decelerates to around 4 percent over the medium term if under-implementation and under-investment persist. Reserves supported by import under-execution; risk of debt distress remains low.
  - Reform scenario: adopting staff policy advice (strengthening capital-budget implementation, developing FDI-financed hydropower projects with construction starting in 2017/18) could accelerate growth to about 6 percent by 2019/20, but would be import intensive and could produce modest current account deficits and lower reserves.
- Downside risks:
  - Continued political instability and disruptions to trade routes and transportation.
  - Possibility of significant under-execution of the ambitious 2015/16 budget (delays in operationalizing the National Reconstruction Authority).
  - Risks to remittances and to the financial sector.

### Authorities’ view (summary)
- Authorities more optimistic on growth; expected confidence effects from the new constitution and hoped streamlined procedures and NRA operationalization would underpin pickup in capital and reconstruction spending.
- Expected growth above 5 percent in 2015/16 due to these factors and base effects from low 2014/15 growth.

---

### Fiscal policy: objectives, outcomes, and recommended limits
- Historical performance and needs:
  - Fiscal policy was tighter than planned due to budget implementation bottlenecks, leaving a large infrastructure gap mostly unaddressed.
  - Fiscal policy must support post-earthquake reconstruction and medium-term growth through higher public investment financed by higher tax revenues, external grants and loans, and domestic financing.
- 2015/16 budget targets and risks:
  - The 2015/16 budget aims for a 44 percent increase in current spending and a 168 percent increase in capital spending relative to 2014/15 outturns.
  - IMF presentation records the 2015/16 overall fiscal deficit—measured by the net incurrence of liabilities—at 4.9 percent of GDP, compared to a surplus of 0.3 percent of GDP in 2014/15.
  - Full implementation of the 2015/16 budget is considered highly unlikely due to implementation challenges and delays in operationalizing the NRA.
- Staff recommendations:
  - Anchor fiscal policy by a ceiling on net domestic financing (NDF).
  - NDF should not exceed 1 percent of GDP per annum to protect international reserves and ensure space for private sector credit growth, taking into account the exchange rate peg.
  - High-quality capital spending financed by concessional donor inflows should be accommodated.
  - With staff projections for concessional foreign financing, this implies:
    - An overall fiscal deficit of 3¾ percent of GDP per annum in the short term.
    - An overall fiscal deficit of 2½ percent of GDP per annum in the medium term (reform scenario).
  - If capital spending shortfalls occur, the deficit should be reduced one for one with shortfalls in donor-financed spending (reducing NDF accordingly and increasing NFA for any donor financing received but not spent).
  - Reforms to strengthen budget implementation are necessary.

### Fiscal revenue and tax administration recommendations
- Observations:
  - Revenue has grown in recent years but at a decreasing rate; revenue fell short of the FY2014/15 budget.
  - The ambitious revenue target for FY2015/16 implies a strong possibility of another shortfall.
- Staff recommendations:
  - The Inland Revenue Department (IRD) should ensure taxpayer compliance is not adversely affected by the earthquake and current unrest.
  - Work closely with FAD in drafting a unified tax code.
  - Use findings and recommendations of a VAT-GAP analysis conducted by a recent FAD mission to formulate an action plan to improve tax administration and compliance.

---

### Public financial management (PFM) and capital budget execution
- Key problems and recent steps:
  - Budget execution suffers from persistent structural weaknesses such as poor project management and bureaucratic hindrances; the earthquake added urgency to improve capital budget execution.
  - Capital budget implementation remained slow in the first two months of the fiscal year.
  - Authorities announced steps to expedite expenditure and simplify approval processes.
  - Staff welcomed MOF’s efforts to draft a Fiscal Responsibility and Budget Management Act (FRBM); it should be put in place in time for the start of the next fiscal year.
  - Staff welcomed the preparation of the PFM Reform Action Plan (following the PEFA Assessment in May) and encouraged focusing the Plan on key priorities for each agency and implementing it as soon as possible.
- FAD PFM technical assistance reiterated to enhance upstream project preparation, appraisal and selection, including:
  - (i) establishing proper and transparent planning, selection and implementation for major capital projects;
  - (ii) developing better targeted selection and prioritization criteria based on cost-benefit analyses, project life cycle and future recurrent costs, project implementation readiness, as well as associated risks.
- Procedural changes (as highlighted in source footnote):
  - For spending items included in the approved budget, government bodies are no longer required to obtain authorization from the District Development Committee, the line ministry and the NPC.
  - Multi-year projects included in the approved budget in one year no longer need to be re-authorized at the start of each fiscal year.
  - Projects with minimal implementation will henceforth need to surrender budget resources.
  - A revised employee performance evaluation system will incentivize project completion.

### Debt management
- Joint IMF/World Bank Debt Sustainability Analysis: risk of debt distress remains low.
- DeMPA (World Bank, August 2014) recommendations:
  - Task one entity with preparation of a comprehensive debt management strategy.
  - Analyze the costs and risks of the debt portfolio.
  - Make debt service forecasts more robust.
- Debt management needs strengthening given increasingly complex debt instruments and larger future borrowing, particularly related to hydropower development.

### Social spending and SOEs
- Social spending priorities:
  - Protect priority social spending and improve safety net effectiveness.
  - Growth of spending on health and education has stagnated in the last few years.
  - Staff noted the macro framework in the reform scenario can accommodate an increase in current spending by almost 2 percent of GDP per annum; once earthquake-related spending is phased out, a rising share should be allocated to social spending.
- SOE concerns:
  - Combined losses of the Nepal Electricity Authority (NEA) and Nepal Oil Corporation (NOC) averaged about 1½ percent of GDP per year in recent years.
  - Recommendations:
    - Adhere to the automatic bi-weekly oil price adjustment mechanism introduced in 2014.
    - Review electricity tariffs more regularly.
    - Scrutinize NEA operations closely; remaining losses should be covered by transparent budget transfers.

---

### Monetary and exchange rate policy
- Exchange rate regime:
  - The peg to the Indian rupee serves as a transparent anchor; staff view focus should be on competitiveness-enhancing structural reforms to support the peg.
- Money growth and inflation:
  - Money growth should be contained to a level consistent with supporting the peg.
  - By mid-2014, Nepal’s inflation began to decouple from India’s; the earthquake has exacerbated the decoupling.
  - Given disruption, some temporary increase in inflation is inevitable and should be accommodated.
  - As the economy recovers, NRB should aim to keep Nepalese inflation close to that in India to maintain competitiveness.
  - Efforts should be made to contain the growth of broad money in 2015/16.
- Strengthening monetary operations:
  - Positive steps: creation of separate open market committees for public debt management and monetary management; introduction of deposit auctions in August 2014.
  - Next steps recommended:
    - Hold regular pre-announced deposit auctions to mop up excess liquidity and systematically raise short-term interest rates, closing the gap with interbank rates in India.
    - Refine liquidity forecasting framework.
    - Adopt an interest rate corridor to guide short-term rates and strengthen monetary transmission.
    - Introduce treasury sterilization bonds to address structural excess liquidity, using NRB repo/reverse repo for fine-tuning.
    - Consider phasing out NRB’s directed lending facilities and gradually transferring them to the budget.

### Authorities’ monetary view
- Authorities favored a looser monetary policy stance to promote growth and broadly concurred with staff’s exchange rate assessment.
- Authorities indicated broad money should expand by at least 15 percent to support growth.
- Authorities view NRB’s directed lending facilities as needed to achieve inclusive growth objectives and expected interest rates to rise once government spending picks up.

---

### Financial sector reforms and FSAP follow-up
- Key recommendations and actions:
  - Strengthen taskforces following up FSAP recommendations; consider an apex committee with mandate, technical support, resources and timetable.
  - Continue to strengthen bank supervision:
    - Complete first cycle of risk-based supervision (RBS) on-site inspections.
    - Strengthen off-site supervision and integrate off-site and on-site functions as SIS is put in place.
    - Develop program to hire, train and retain supervisory staff; revisit staff rotation policy.
  - Limit further forbearance; NRB indicated post-earthquake forbearance on asset classification and provisioning will remain limited and time-bound.
  - Extend legal upgrades to secondary legislation and regulations; identify prudential regulation priorities and begin upgrades.
  - Convert NRB Risk Management guideline to a directive and provide guidance for transition to IFRS.
  - Use results of the Special Inspections Program to prepare a diagnostic of earthquake impact on banks (special inspection of 54 BFIs representing 64 percent of the banking system by DFID, coordinated with World Bank and IMF).
  - Develop strategy to resolve unviable BFIs and address possible capital shortfalls; develop operational framework for bank resolution.
  - Formalize monitoring of banks’ capital-raising plans during the two-year phase-in period to increase paid-up capital; establish contingency plans with corrective action and administrative sanctions.

### AML/CFT and safeguards
- AML/CFT:
  - Staff welcomed enactment of AML/CFT ordinances and Nepal’s exit from FATF enhanced scrutiny in June 2014.
  - Implementation should be further strengthened via issuing implementing rules and applying risk-based supervisory tools with IMF TA.
- NRB safeguards assessment (September 2015):
  - Limited progress since 2011 recommendations.
  - Positive developments: new accounting system and improved financial reporting practices.
  - Key functions needing modernization: internal audit and currency and vault operations.
  - Priorities: engage an auditor with requisite global experience in auditing large financial institutions; enhance NRB legal framework to support central bank autonomy and governance.

### Authorities’ financial sector views
- Authorities broadly agreed with recommendations and requested technical assistance and training.
- Special Inspections Program expected to be completed by October.
- NRB asked DFID to proceed with a “fast diagnostic” of earthquake impact on banks and insurance companies.
- NRB would consider modalities for monitoring banks’ capital plans and aim to issue the Risk Management directive by February 2016.

---

### Enabling sustainable and inclusive growth; hydropower potential
- Business climate and labor reforms:
  - Improve trading across borders, contract enforcement, tax processes and access to credit.
  - Staff welcomed extension of one-stop-shop for new company registration and recommended further investor facilitation.
  - Labor market reforms needed to streamline labor code and procedures; strengthen environmental impact assessment processes.
- Hydropower potential and projects:
  - Commercially viable hydropower potential estimated at 43,000 MW; less than one percent is currently exploited.
  - Selected planned large hydropower projects (figures preserved exactly):
    - Upper Tamakoshi — Capacity (MW): 456; Cost (US$m): 441; Expected completion: 2017; Developer: Upper Tamakoshi Hydro Power Ltd, Subsidiary of NEA; Status: Slated for completion by late-2017.
    - West Seti — Capacity (MW): 750; Cost (US$m): 1,000; Expected completion: 2022; Developer: Three Gorges, China; Status: Cleared by Investment Board in April 2015. Special Purpose Vehicle is being formed and on-site investigation is underway.
    - Upper Karnali — Capacity (MW): 900; Cost (US$m): 1,050; Expected completion: 2021; Developer: GMR, India; Status: Project development agreement signed in Sept. 2014. Financial closure expected in Sept. 2016.
    - Arun-3 — Capacity (MW): 900; Cost (US$m): 1,009; Expected completion: 2020; Developer: SJVNL, India; Status: Project development agreement signed in November 2014.
    - Total — Capacity (MW): 3,006; Cost (US$m): 3,500.
    - Memorandum items: Current power production (MW): 800; Current power demand (MW): 1,400.
  - Staff encouraged consideration of a special high-qualified project committee to establish realistic timetables and spearhead progress on large hydro projects.

---

### Key macro projections and statistics (selected exact figures)
- Real GDP growth (actual and projections):
  - 2012/13: 4.1
  - 2013/14: 5.4
  - 2014/15: 3.4
  - 2015/16 (projection): 4.4
  - 2016/17 (projection): 5.4
  - 2017/18 (projection): 3.9
  - 2018/19 (projection): 3.8
  - 2019/20 (projection): 3.8
- Inflation (CPI period average and end of period):
  - CPI (period average): 2014/15: 7.2; 2015/16: 8.0; 2016/17: 8.3; 2017/18: 7.7; 2018/19: 7.0; 2019/20: 6.1
  - CPI (end of period): 2014/15: 7.6; 2015/16: 8.5; 2016/17: 8.0; 2017/18: 7.5; 2018/19: 6.5; 2019/20: 5.7
- Remittances (US$ millions and percent of GDP):
  - Workers' remittances (US$ m): 2014/15: 6,192; 2015/16 (proj): 6,631; 2016/17 (proj): 7,131; 2017/18 (proj): 7,698; 2018/19 (proj): 8,308; 2019/20 (proj): 8,964
  - Remittances percent of GDP: 2014/15: 29.0; 2015/16 (proj): 28.9; 2016/17 (proj): 28.3; 2017/18 (proj): 28.3; 2018/19 (proj): 28.8; 2019/20 (proj): 29.3
- Gross official reserves (US$ millions):
  - 2012/13: 4,972
  - 2013/14: 6,172
  - 2014/15: 7,162
  - 2015/16 (proj): 7,320
  - 2016/17 (proj): 7,594
  - 2017/18 (proj): 8,003
  - 2018/19 (proj): 8,548
  - 2019/20 (proj): 9,138
- Current account (US$ millions and percent of GDP projections):
  - Current account (US$ m): 2014/15: 1,067; 2015/16 (proj): -570; 2016/17 (proj): -426; 2017/18 (proj): -452; 2018/19 (proj): -352; 2019/20 (proj): -234
  - Current account (percent of GDP under baseline): 2015/16 (proj): -2.5; 2016/17 (proj): -1.7; 2017/18 (proj): -1.7; 2018/19 (proj): -1.2; 2019/20 (proj): -0.8
- Public debt (percent of GDP):
  - 2012/13: 32.3; 2013/14: 28.3; 2014/15: 25.7; 2015/16 (proj): 28.9; 2016/17 (proj): 29.4; 2017/18 (proj): 29.6; 2018/19 (proj): 28.7; 2019/20 (proj): 28.0
- Monetary aggregates:
  - Broad money (y/y percent change): 2014/15: 19.9; 2015/16 (proj): 12.8; 2016/17 (proj): 15.0
- Financial soundness indicators (selected):
  - Capital fund to risk weighted assets: 2014: 12.0; 2015: 11.9
  - NPLs to total loans: 2014: 2.9; 2015: 2.6
  - Return on equity (ROE): 2014: 24.5; 2015: 28.0

---

### Appendix I — Progress on high-priority FSAP recommendations (selected status highlights)
- Monetary operations and liquidity management:
  - Recommendation to refocus monetary policy operations and introduce Treasury sterilization bonds — Responsible Authority: NRB; Time Line: ST; Progress to date: In process; NRB has been holding deposit auctions intermittently since August 2014; introduction of Treasury sterilization bonds under discussion.
- Asset Quality Review (AQR):
  - Undertake a thorough AQR — Responsible Authority: NRB; Time Line: ST; Progress to date: Not done; Lack of AQR largely offset by special investigations conducted by KPMG in conjunction with NRB supervisors covering BFIs holding about 64% of assets.
- Supervisory reforms:
  - Redefine supervisory approach to integrate risk-based off-site and on-site supervision, develop MIS, HR policy — Responsible Authority: NRB; Time Line: ST/MT; Progress to date: In process / not done.
- Crisis management and legal framework:
  - Revise PCA policy, clarify ELA provisions, and grant NRB special resolution regime powers — Responsible Authority: NRB/MOF; Time Line: ST; Progress to date: Under consideration / In preparation; NRB Act Amendments tabled in Parliament.
- Non-banking sector and market infrastructure:
  - Strengthen payment systems, credit information, collateral registry, and debt recovery — Responsible Authority: NRB/MOF; Time Line: ST/MT; Progress to date: In process.

---

### Humanitarian, transport disruption, and authorities’ November 16, 2015 statement (selected points)
- Transportation and fuel disruption:
  - Disruption to transport and trade routes to/from the southern border started two days after the September 20 promulgation of the constitution.
  - Oil imports represented 15 percent of Nepal’s total goods imports, amounting to US$1.1 billion or 5.3 percent of GDP in the last fiscal year.
  - NOC is the sole supplier; IOC is NOC’s sole supplier. NOC curtailed fuel sales for private vehicles and prioritized security forces; Forest Ministry announced providing firewood as alternative fuel.
- Macroeconomic and humanitarian impacts:
  - Economic activity slowed markedly; delivery of emergency supplies to remote earthquake-affected regions affected; near-term outlook bleak with winter approaching for those rendered homeless.
  - Humanitarian organizations urgently require fuel to maintain operations.
- Authorities’ statement highlights:
  - Earthquakes resulted in damages and losses estimated at about US$7 billion, equivalent to nearly one-third of GDP.
  - Real GDP averaged 4.5 percent growth in the last five years but grew by only 3.0 percent in 2014/2015 due to the earthquakes.
  - Inflation moderated to 7.2 percent in 2014/2015; headline inflation for the first two months of 2015/2016 averaged 7.05 percent.
  - Balance of payments surplus reached US$1.43 billion in 2014/2015.
  - Gross foreign exchange reserves were US$8.28 billion as of mid-September 2015, equivalent to more than 11 months of imports.
  - Authorities earlier projected GDP growth of 6.0 percent for 2015/2016; prolonged drought and trade blockade-like situation pose risks.
- Fiscal and reconstruction actions announced by authorities:
  - NRA to be established to coordinate rehabilitation and reconstruction over the next five years; reconstruction budget of NPR 91 billion (USD 900 million) announced in July 2015 budget speech.
  - In the annual budget for 2015/2016, more than US$8 billion was allocated for reconstruction and development, with US$740 million for the National Reconstruction Fund.
  - Authorities to expedite approvals, simplify administrative procedures, redirect allocations from unimplemented and slow-moving projects to ongoing projects, and prioritize projects with completed feasibility studies.

---

*Source: INTRODUCTION, Policy Discussions, PFM, Macroeconomic Outlook, FSAP Appendix, and Authorities’ statement excerpts of IMF Country Report _cr15317 (Nepal).*

### INTRODUCTION __________________________________________________________________________________  4

### INTRODUCTION

### Recent developments and impacts of the earthquakes
- Two massive earthquakes in April and May resulted in:
  - Over 8,800 lives lost.
  - Damages and losses estimated at US$7 billion or nearly one third of GDP.
  - Multilateral and bilateral donors pledged more than US$4 billion in grants and concessional loans to be disbursed over five years (pledged at June 25 donor conference).
  - The authorities requested the equivalent of SDR35.65 million (50 percent of quota) under the Fund’s Rapid Credit Facility; the funds were disbursed as direct budget support.
- Political developments following the September 20 promulgation of the constitution:
  - Triggered unrest, a fuel crisis, and a change in government.
  - Disruptions to transportation and trade routes to/from the southern border caused shortages of fuel and other imported goods.
  - Parliament voted out the Prime Minister; a new Prime Minister and Cabinet were inaugurated in mid-October.

### Macroeconomic status and recent performance
- Structural context:
  - Nepal remains Asia’s poorest country despite progress with poverty reduction.
  - Poverty declined from over 50 percent in 2003/04 to just under 25 percent in 2010/11.
  - Remittances currently amount to about 29 percent of GDP.
- 2014/15 outturns and near-term status:
  - Real GDP growth: 3.4 percent in 2014/15 (pre-earthquake baseline forecast was 5 percent); growth had been 5.5 percent in 2013/14 and averaged 4 percent in the three previous years.
  - Inflation: accelerated to 6.9 percent in August (y/y).
  - Government spending: preliminary data suggest a 28 percent increase in capital spending in 2014/15.
  - Fiscal position: budget recorded a surplus (third year in a row) despite revenues falling short of the budget for the first time in several years.
  - Public debt: fell to 26 percent of GDP in 2014/15 from 32 percent of GDP in 2012/13.
  - External sector: current account surplus of 5.0 percent of GDP in 2014/15, aided by a surge in remittances and lower oil import prices.
  - Reserves: US$7.2 billion, or 33 percent of GDP, covering almost eight months of prospective imports.
  - Financial system: as of July 2015, commercial and development banks had capital adequacy ratios comfortably in excess of the required minima (6 percent) and reported low non-performing loans.

### Outlook and risks
- Staff projections:
  - Growth is expected to rebound gradually to around 5½ percent by 2016/17 as reconstruction gains momentum.
  - Inflation is projected to rise to about 8½ percent over the next 12 months.
  - Reconstruction-related foreign aid and higher remittances will boost liquidity pressures, requiring active liquidity management to avoid excess inflation relative to India.
- Scenario dependence and medium-term prospects:
  - Baseline scenario: initial donor-funded reconstruction rebound; growth decelerates to around 4 percent over the medium term if under-implementation of the budget and under-investment persist. Reserves supported by import under-execution; risk of debt distress remains low (per RCF staff report).
  - Reform scenario: adopting staff policy advice (strengthening capital-budget implementation, developing FDI-financed hydropower projects with construction starting in 2017/18) could accelerate growth to about 6 percent by 2019/20, but would be import intensive and could produce modest current account deficits and lower reserves.
- Downside risks (Table 2 highlights):
  - Continued political instability and disruptions to trade routes and transportation.
  - Possibility of significant under-execution of the ambitious 2015/16 budget (delays in operationalizing the National Reconstruction Authority).
  - Risks to remittances and to the financial sector.

### Authorities’ view
- Authorities were more optimistic on growth, viewing unrest and trade-route disturbances as temporary.
- Expected confidence effects from the new constitution and hoped that streamlined spending procedures and operationalization of the NRA would underpin an important pickup in government capital and reconstruction spending following the October/November festival season.
- Expected growth above 5 percent in 2015/16 due to these factors and base effects from low 2014/15 growth.

### Poverty, migration, and human development
- Lack of domestic opportunities has driven large out-migration, mainly to Persian Gulf countries and Malaysia.
- Output per capita remains the lowest in the region; further efforts needed to improve human development indicators (Table 9).

---

### POLICY DISCUSSIONS

### Fiscal policy: objectives, outcomes, and constraints
- Historical performance:
  - Fiscal policy was tighter than planned due to budget implementation bottlenecks, leaving a large infrastructure gap mostly unaddressed.
  - Strong revenue collection alongside spending under-implementation kept public debt on a declining path compared with other low-income countries.
- Needs going forward:
  - Fiscal policy must support post-earthquake reconstruction and medium-term growth through higher public investment, financed by a combination of higher tax revenues, external grants and loans, and domestic financing.
- 2015/16 budget targets and implementation risks:
  - The 2015/16 budget aims for a 44 percent increase in current spending and a 168 percent increase in capital spending relative to 2014/15 outturns.
  - IMF presentation records the 2015/16 overall fiscal deficit—measured by the net incurrence of liabilities—at 4.9 percent of GDP, compared to a surplus of 0.3 percent of GDP in 2014/15.
  - Full implementation of the 2015/16 budget is considered highly unlikely due to persistent implementation challenges and delays in operationalizing the NRA.
- Staff recommendations on fiscal management and limits:
  - Anchor fiscal policy by a ceiling on net domestic financing of the budget (NDF).
  - NDF should not exceed 1 percent of GDP per annum to protect international reserves and ensure space for private sector credit growth, taking into account the exchange rate peg.
  - High-quality capital spending financed by concessional donor inflows should be accommodated.
  - With staff projections for concessional foreign financing, this implies:
    - An overall fiscal deficit of 3¾ percent of GDP per annum in the short term.
    - An overall fiscal deficit of 2½ percent of GDP per annum in the medium term (reform scenario).
  - If capital spending shortfalls occur, the deficit should be reduced one for one with shortfalls in donor-financed spending (reducing NDF accordingly and increasing NFA for any donor financing received but not spent).
  - Reforms to strengthen budget implementation are necessary (see ¶16 in source).

### Fiscal revenue and tax administration recommendations
- Continued improvements in revenue performance are important to maintain a strong fiscal position and finance higher capital expenditure.
- Observations:
  - Revenue has grown in recent years but at a decreasing rate; revenue fell short of the FY2014/15 budget.
  - The ambitious revenue target for FY2015/16 implies a strong possibility of another shortfall.
- Staff recommendations:
  - The Inland Revenue Department (IRD) should ensure taxpayer compliance is not adversely affected by the earthquake and current unrest.
  - Staff welcomed the review of the tax policy framework and the intent to commence implementation of various policy reforms from FY2015/16.
  - Authorities are encouraged to work closely with FAD in drafting a unified tax code.
  - Findings and recommendations of a VAT-GAP analysis conducted by a recent FAD mission should be used to formulate an action plan to improve tax administration and compliance.

---

*Source: INTRODUCTION section of IMF Country Report _cr15317 (Nepal).*

### 15.      Stronger public financial management (PFM) will be key to the swift and efficient

### 15.      Stronger public financial management (PFM) will be key to the swift and efficient implementation of post-earthquake reconstruction as well as the “regular” capital budget

### Public financial management and capital budget execution
- Budget execution in Nepal suffers from persistent structural weaknesses such as poor project management and bureaucratic hindrances; the earthquake added urgency to improve capital budget execution.
- Capital budget implementation remained slow in the first two months of the fiscal year.
- Authorities recently announced steps to expedite expenditure and simplify approval processes.
- Staff welcomed the MOF’s ongoing efforts to draft a Fiscal Responsibility and Budget Management Act (FRBM); it should be put in place in time for the start of the next fiscal year.
- Staff welcomed the preparation of the PFM Reform Action Plan (following the PEFA Assessment in May) and encouraged focusing the Plan on key priorities for each agency and implementing it as soon as possible.
- FAD PFM technical assistance advice reiterated to enhance upstream project preparation, appraisal and selection, including:
  - (i) establishing proper and transparent planning, selection and implementation for major capital projects;
  - (ii) developing better targeted selection and prioritization criteria based on cost-benefit analyses, project life cycle and future recurrent costs, project implementation readiness, as well as associated risks.
- Footnote (policy changes highlighted):
  - For spending items included in the approved budget, government bodies are no longer required to obtain authorization from the District Development Committee, the line ministry and the NPC, a process that could take up to six months.
  - Multi-year projects included in the approved budget in one year no longer need to be re-authorized at the start of each fiscal year.
  - Projects with minimal implementation will henceforth need to surrender budget resources.
  - A revised employee performance evaluation system will incentivize project completion.

### Debt management
- The joint IMF/World Bank Debt Sustainability Analysis concluded Nepal’s risk of debt distress remains low.
- A Debt Management Performance Assessment (DeMPA) (World Bank, August 2014) called for improving managerial oversight of debt management functions.
- DeMPA recommendations:
  - Task one entity with preparation of a comprehensive debt management strategy.
  - Analyze the costs and risks of the debt portfolio.
  - Make debt service forecasts more robust.
- Debt management needs strengthening given increasingly complex debt instruments and larger future borrowing, particularly related to hydropower development.

### Social spending and state-owned enterprises (SOEs)
- Protecting priority social spending and improving safety net effectiveness are important.
- The growth of spending on health and education has stagnated in the last few years.
- Staff noted the macro framework in the reform scenario can accommodate an increase in current spending by almost 2 percent of GDP per annum.
- Once earthquake-related spending is phased out, a rising share of this increase should be allocated to social spending.
- Large SOEs in the energy sector need to be put on a sound financial footing to reduce contingent liabilities and encourage private and foreign investment.
  - Combined losses of the Nepal Electricity Authority (NEA) and Nepal Oil Corporation (NOC) averaged about 1½ percent of GDP per year in recent years.
  - Recommendations:
    - Adhere to the automatic bi-weekly oil price adjustment mechanism introduced in 2014.
    - Review electricity tariffs more regularly.
    - Scrutinize NEA operations closely; remaining losses should be covered by transparent budget transfers.

### Authorities’ views (PFM, social spending, NDF ceiling)
- Authorities were confident capital budget implementation would pick up from mid-November after the festival season and would end higher relative to the last fiscal year, in part due to simplification of administrative procedures.
- They acknowledged scope to improve implementation capacity and strengthen procurement and public/private construction sector capacity.
- Authorities viewed the 1 percent of GDP ceiling on NDF as too restrictive given abundant liquidity in the financial system.
- Authorities noted social spending had been rising steadily in absolute terms and much reconstruction spending would be on schools and health facilities; they also noted local governments carry out social spending but tracking is difficult.
- On retail fuel prices, authorities stressed maintaining parity with prices across the border to prevent distortions.

### Monetary and exchange rate policy
- The peg to the Indian rupee serves as a transparent anchor and benefits Nepal given close economic ties with India.
- Staff view: focus should be on competitiveness-enhancing structural reforms to support the peg; installing enough hydropower capacity to eliminate load shedding could boost the investment climate.
- Money growth should be contained to a level consistent with supporting the peg.
  - By mid-2014, Nepal’s inflation began to decouple from India’s; the earthquake has exacerbated the decoupling.
  - Given disruption, some temporary increase in inflation is inevitable and should be accommodated.
  - As the economy recovers, NRB should aim to keep Nepalese inflation close to that in India to maintain competitiveness.
  - Efforts should be made to contain the growth of broad money in 2015/16 (Table 5 referenced).
- Strengthening the monetary operations framework:
  - Positive step: creation of separate open market committees for public debt management and monetary management since the FSAP.
  - Introduction of deposit auctions in August 2014 welcomed; these have at times mopped up excess liquidity.
  - Next steps:
    - Hold regular pre-announced deposit auctions to mop up excess liquidity and systematically raise short-term interest rates from current low levels, closing the gap with interbank rates in India.
    - Refine liquidity forecasting framework (build on FSAP and MCM TA suggestions).
    - Adopt an interest rate corridor to guide short-term rates and strengthen monetary transmission.
    - Introduce treasury sterilization bonds to address structural excess liquidity, using NRB repo/reverse repo for fine-tuning; treasury sterilization bonds would foster capital market development and make the cost of monetary tightening transparent in the budget.
    - Consider phasing out NRB’s directed lending facilities and gradually transferring them to the budget, as they complicate monetary policy and are not core central bank functions.

### Authorities’ views (monetary policy)
- Authorities favored a looser monetary policy stance to promote growth and broadly concurred with staff’s exchange rate assessment.
- By virtue of the peg to the Indian rupee, India’s disinflation gains were expected to spill over to lower inflation in Nepal.
- Authorities indicated broad money should expand by at least 15 percent to support growth.
- In view of market imperfections, NRB’s directed lending facilities are viewed as needed to achieve inclusive growth objectives.
- Authorities expected interest rates to rise once government spending picks up.
- They were examining monetary operations frameworks other than the interest rate corridor and questioned the relevance of treasury sterilization bonds in the context of a separation of public debt management and monetary management.

### Financial sector reforms
- Steps taken to address legal and supervisory framework weaknesses highlighted by the 2014 FSAP; FSAP stress tests suggest banking system strains if asset quality deteriorates moderately.
- Staff recommended follow-through on existing initiatives plus additional reforms; key recommendations include:
  - Strengthen taskforces following up FSAP recommendations; consider an apex committee with mandate, technical support, resources and timetable.
  - Continue to strengthen bank supervision:
    - Complete first cycle of risk-based supervision (RBS) on-site inspections.
    - Significantly strengthen off-site supervision and integrate off-site and on-site functions as SIS is put in place.
    - Develop a program to hire, train and retain supervisory staff; revisit the staff rotation policy that has undermined supervisory continuity.
  - Limit further forbearance; welcome NRB’s statement that post-earthquake forbearance on asset classification and provisioning will remain limited in scope and time-bound.
  - Extend legal upgrades to secondary legislation and regulations; identify prudential regulation priorities and begin upgrades.
  - Convert NRB Risk Management guideline to a directive to officially introduce risk management requirements and level the playing field; provide guidance for industry transition to IFRS.
  - Use results of the Special Inspections Program to prepare a diagnostic of earthquake impact on banks:
    - Ongoing special inspection of 54 BFIs representing 64 percent of the banking system by DFID, in coordination with World Bank and IMF; perform additional diagnostics to determine resilience.
    - Develop a strategy to resolve unviable BFIs and address possible capital shortfalls.
  - Develop an operational framework for bank resolution by drawing up implementing regulations building on laws submitted to Parliament.
  - Formalize a system to monitor banks’ capital-raising plans:
    - Two-year phase-in period to increase paid-up capital requires diligent NRB oversight.
    - Establish a formal review process to ensure each BFI internalizes obligation to increase capital and adheres to capital plans.
    - Include robust review of accounting techniques to minimize potential for overstated earnings.
    - Establish a contingency plan with corrective action and administrative sanctions in case of failure to meet required capital levels.

### AML/CFT and safeguards
- AML/CFT:
  - Staff welcomed enactment of AML/CFT ordinances and Nepal’s exit from FATF enhanced scrutiny in June 2014.
  - Implementation should be further strengthened via issuing implementing rules and applying risk-based supervisory tools supported by ongoing IMF TA.
- Safeguards assessment of NRB:
  - A safeguards assessment mission in September 2015 found limited progress since 2011 recommendations.
  - Positive developments: new accounting system and improved financial reporting practices.
  - Key functions needing modernization: internal audit and currency and vault operations.
  - Priorities:
    - Bring the quality of external audit into compliance with international standards by engaging an auditor with requisite global experience in auditing large financial institutions.
    - Enhance the NRB's legal framework to further support central bank autonomy and governance.

### Authorities’ views (financial sector reforms)
- Authorities broadly agreed with recommendations and requested technical assistance and training.
- Special Inspections Program expected to be completed by October.
- NRB asked DFID to proceed with preparation of a “fast diagnostic” of earthquake impact on banks and insurance companies.
- NRB would consider modalities for monitoring banks’ implementation of their capital plans and aim to issue the Risk Management directive by February 2016.

### Enabling sustainable and inclusive growth
- Improve the business climate: considerable scope to simplify trading across borders, enforce contracts, pay taxes and get credit.
- Staff welcomed extension of the one-stop-shop for registration of new companies to any investor; recommended further improvement (e.g., strengthening investment facilitation coordination committee).
- Labor market reforms needed: streamline complex labor code and procedures (e.g., environmental impact assessments) and strengthen policy frameworks to boost private-sector-led investment.
- Hydropower potential:
  - Unlocking hydropower would relieve power shortages and enable power exports to diversify foreign exchange earnings.
  - Staff welcomed the Power Trade Agreement with India and Project Development Agreements for two large hydropower projects with foreign investors.
  - Staff encouraged considering a special high-qualified project committee to establish realistic project timetables and spearhead progress on large hydro projects given past failures and project complexity and duration.

### Key objectives of a possible ECF arrangement
- A possible ECF arrangement would focus on supporting government efforts to recover from the earthquakes and potentially longer-term Fund engagement depending on the new government’s interest.
- Arrangement aim: boost public and private investment, social spending and financial inclusion, and address financial system weaknesses to improve growth prospects and poverty reduction while preserving macroeconomic stability.
- Program focus areas:
  - (i) public capital budget management;
  - (ii) monetary policy operations;
  - (iii) financial sector reforms;
  - (iv) the business climate.
- Transition to higher growth trajectory will create additional external financing needs beyond earthquake reconstruction.
- Access to IMF resources—like in the RCF—would be disbursed to MOF’s account at the NRB and would depend on program strength; a more robust reform agenda would come with greater BOP and fiscal financing need—currently suppressed by budget under-execution and under-investment.

*Source: IMF staff report excerpt — _cr15317 - 15. Stronger public financial management (PFM) will be key to the swift and efficient implementation of post-earthquake reconstruction and the regular capital budget._*

### 33.      Macroeconomic performance has been held back by the earthquakes and the ongoing

### _cr15317 - 33.      Macroeconomic performance has been held back by the earthquakes and the ongoing

### Macroeconomic impact and near-term outlook
- Growth has been dampened by the disruption caused by the natural disaster and the recent unrest and the under implementation of the budget.
- Supply shocks from the earthquake and trade disruption have caused inflation to rise, exacerbating its decoupling from the declining path of inflation in India.
- Remittances have continued to support consumption, poverty reduction, and high international reserves.
- Growth is expected to gradually rebound as reconstruction gains momentum but inflation is projected to rise over the next 12 months.
- Losses in agricultural production and damage to transport systems, plus disruption to trade routes, represent a large shock to the supply of agricultural products and other goods; over time as agricultural production recovers and transportation infrastructure improves, inflation pressure should ease.

### Medium-term outlook and reform scenario
- The medium-term outlook depends importantly on the authorities’ reform efforts; natural disasters can have permanent effects on potential growth.
- In a “reform scenario,” post-earthquake reconstruction growth would be sustained by:
  - strengthening the government’s capital budget implementation capacity, and
  - a persistent push to develop large FDI-financed hydropower projects.
- Because hydropower projects are highly import intensive:
  - the current account balance would turn to modest deficits in the medium term due to higher imports,
  - reserves would be lower than in the baseline,
  - external debt would remain manageable and continue to be contracted largely on highly concessional terms.

### Downside risks to the baseline
- Recent developments have heightened downside risks:
  - continued political instability and disruptions to trade to and from the southern border could severely affect growth and inflation in this fiscal year;
  - government capacity to boost capital spending is an important downside risk;
  - delay in setting up the National Reconstruction Authority (NRA) may limit the increase in expenditure.
- Risk Assessment Matrix highlights (selected items):
  - Post-earthquake reconstruction is slow — Likelihood: High; Impact: High; Policy response: Boost government's ability to manage capital expenditure and reconstruction projects.
  - Political instability — Likelihood: High; Impact: Medium/High; Policy response: Preserve fiscal and external policy space.
  - Financial sector distress — Likelihood: Medium; Impact: Medium/High; Policy response: Pro-active and risk-based supervision, increase resources for supervision.
  - Natural disaster (future) — Likelihood: Low; Impact: Medium/High; Policy response: (i) adhere to disaster-proof building codes, (ii) accelerate structural reforms to diversify the economy, (iii) build fiscal space and reserves buffers, (iv) enhance financial safety nets.
  - Persistently low energy prices (remittance risk) — Likelihood: Medium; Impact: Medium/High; Policy response: Strengthen financial sector and preserve fiscal and external policy space; longer term boost public investment and pursue structural reforms.
  - Slower-than-projected growth in India — Likelihood: Medium; Impact: Medium; Policy response: Accelerate structural reforms and boost public investment.

### Fiscal policy recommendations
- Fiscal policy needs to support post-earthquake reconstruction spending and medium-term growth through higher public investment.
- Priorities:
  - Establish proper and transparent planning, selection, and implementation for major capital projects.
  - Continue improvements in revenue performance to maintain a strong fiscal position.
  - Use concessional external financing to finance the bulk of sustained increase in government capital spending to address infrastructure gaps.
- Given the exchange rate peg, the need to protect international reserves, and ensure adequate space for private sector credit growth, fiscal policy should be anchored by a ceiling on net domestic financing of the budget (NDF).

### Monetary policy and liquidity management
- Monetary policy should support the exchange rate peg, contain inflation, and safeguard reserves.
- As the economy recovers, the central bank needs to closely monitor price developments.
- In light of the exchange rate peg, monetary policy should be oriented to keep Nepalese inflation close to that in India.
- Higher inflows of foreign aid and remittances will boost liquidity pressures, necessitating active liquidity management.

### Financial sector stability and supervisory actions
- Efforts to enhance stability and resilience of the financial sector should be intensified.
- Priorities:
  - Accelerate implementation of high-priority FSAP recommendations.
  - Conduct a diagnostic of earthquake impact on banks.
  - Continue to strengthen the bank supervision function and develop an operational framework for bank resolution.
  - Diligent NRB oversight of the two-year phase-in period to increase banks’ paid up capital.
  - Improve the quality of the NRB’s external audit to comply with international standards and enhance the NRB legal framework to support central bank autonomy and governance.

### Exchange rate assessment, reserves, and external balances
- The peg to the Indian rupee continues to serve as a transparent anchor; the level of the exchange rate remains broadly in line with fundamentals.
- Structural effects of remittances:
  - At almost 30 percent of GDP in 2014, Nepal’s remittances are its most important source of foreign exchange, amounting to 2½ times exports of goods and services and over ⅔ of imports.
  - The bulk of remittances come from migrant workers in Persian Gulf countries and Malaysia.
  - The number of registered migrant workers leaving Nepal hit a record high of almost 600,000 in 2014—very large relative to its population of about 28 million.
  - The growth of remittances has averaged 15 percent since 2009/10.
- Trade and export performance:
  - Exports of goods and services to GDP ratio declined from 16 percent in the early 2000s to 11½ percent in 2014/15.
  - The trade deficit as a share of output reached 31 percent of GDP in 2013/14.
- Reserves:
  - Gross international reserves (including the central bank’s holdings of Indian rupees) reached US$7.2 billion at the end of 2014/15, equal to 7.9 months of prospective imports.
  - Staff view: reserves should be maintained at about 7 months of imports of goods and services not related to FDI-financed projects.
- Exchange rate valuation assessments (econometric approaches):
  - Nepal’s REER appreciated by about 8 percent over the past year (reflecting the inflation differential with India).
  - Current account panel regression approach:
    - current account norm for Nepal is estimated at 1.8 percent of GDP,
    - underlying current account in 2014/15 is 5.0 percent of GDP,
    - assuming a trade balance elasticity to the REER of -0.33, the difference suggests an undervaluation of the REER 9.7 percent.
  - Index equilibrium exchange rate approach: REER is approximately 23 percent overvalued as of end-June 2015.
  - External sustainability approach: current account consistent with stabilizing Nepal’s IIP at the 2013 level of 9.8 percent of GDP is estimated at -0.4 of GDP; taken together with the medium-term projected current account (-1.1 percent of GDP) this suggests the REER is overvalued by 2.1 percent.

### Hydropower potential and planned projects
- Nepal’s commercially viable hydropower generation potential is estimated at 43,000 MW; less than one percent is currently exploited.
- Developing hydropower is a top priority to boost growth and diversify foreign exchange earnings and reduce load shedding.
- Recent developments (notwithstanding earthquake-related damage to Upper Tamakoshi delaying completion to late-2017):
  - Nepal signed a power trade agreement with India in September 2014.
  - Project development agreements signed for Upper Karnali (900MW) and Arun-3 (900MW).
  - Investment Board cleared West Seti (750MW) proposal by a Chinese investor.
  - Capacity of government agencies is being strengthened through technical assistance (World Bank, Japan, United States).
- Table of planned large hydropower projects (selected figures preserved exactly):
  - Upper Tamakoshi — Capacity (MW): 456; Cost (US$m): 441; Expected completion: 2017; Developer: Upper Tamakoshi Hydro Power Ltd, Subsidiary of NEA (Nepal); Status: Slated for completion by late-2017.
  - West Seti — Capacity (MW): 750; Cost (US$m): 1,000; Expected completion: 2022; Developer: Three Gorges, China; Status: Cleared by Investment Board in April 2015. Special Purpose Vehicle is being formed and on-site investigation is underway.
  - Upper Karnali — Capacity (MW): 900; Cost (US$m): 1,050; Expected completion: 2021; Developer: GMR, India; Status: Project development agreement signed in Sept. 2014. Financial closure expected in Sept. 2016.
  - Arun-3 — Capacity (MW): 900; Cost (US$m): 1,009; Expected completion: 2020; Developer: SJVNL, India; Status: Project development agreement signed in November 2014.
  - Total — Capacity (MW): 3,006; Cost (US$m): 3,500.
  - Memorandum items: Current power production (MW): 800; Current power demand (MW): 1,400.

*IMF Staff Report excerpt as provided in the source content.*

### 3.4 percent in 2014/15 due to the earthquake.

### _cr15317 - 3.4 percent in 2014/15 due to the earthquake.

### Macroeconomic developments and inflation
- Real GDP growth:
  - 2012/13: 4.1
  - 2013/14: 5.4
  - 2014/15: 3.4
  - 2015/16 (projection): 4.4
  - 2016/17 (projection): 5.4
  - 2017/18 (projection): 3.9
  - 2018/19 (projection): 3.8
  - 2019/20 (projection): 3.8
- Inflation:
  - CPI (period average): 2012/13: 9.9; 2013/14: 9.0; 2014/15: 7.2; 2015/16: 8.0; 2016/17: 8.3; 2017/18: 7.7; 2018/19: 7.0; 2019/20: 6.1
  - CPI (end of period): 2012/13: 7.7; 2013/14: 8.1; 2014/15: 7.6; 2015/16: 8.5; 2016/17: 8.0; 2017/18: 7.5; 2018/19: 6.5; 2019/20: 5.7
  - Inflation stood at 6.9 percent (y/y) in August (text).
- Real effective exchange rate:
  - REER is 12 percent above the 2013/14 average (text).
- Nominal exchange rate: described as stable (text).

### Remittances, reserves, and external sector
- Remittances:
  - Workers' remittances (in millions of U.S. dollars): 2012/13: 4,931; 2013/14: 5,543; 2014/15: 6,192; 2015/16 (proj): 6,631; 2016/17 (proj): 7,131; 2017/18 (proj): 7,698; 2018/19 (proj): 8,308; 2019/20 (proj): 8,964
  - Remittances in percent of GDP: 2012/13: 25.6; 2013/14: 28.1; 2014/15: 29.0; 2015/16 (proj): 28.9; 2016/17 (proj): 28.3; 2017/18 (proj): 28.3; 2018/19 (proj): 28.8; 2019/20 (proj): 29.3
  - Remittances have picked up after the earthquake (text).
- Gross official reserves:
  - 2012/13: 4,972 (millions of U.S. dollars)
  - 2013/14: 6,172
  - 2014/15: 7,162
  - 2015/16 (proj): 7,320
  - 2016/17 (proj): 7,594
  - 2017/18 (proj): 8,003
  - 2018/19 (proj): 8,548
  - 2019/20 (proj): 9,138
  - Reserves reached a record of US$7.3 billion (text).
  - Reserves in months of prospective GNFS imports: 7.3 (2012/13); 8.3 (2013/14); 7.9 (2014/15); 7.6 (2015/16); 7.3 (2016/17); 7.3 (2017/18); 7.3 (2018/19); 7.3 (2019/20)
- Balance of payments and trade:
  - Current account (in millions of U.S. dollars): 2012/13: 635; 2013/14: 908; 2014/15: 1,067; 2015/16 (proj): -570; 2016/17 (proj): -426; 2017/18 (proj): -452; 2018/19 (proj): -352; 2019/20 (proj): -234
  - Trade balance (in millions of U.S. dollars): 2012/13: -5,247; 2013/14: -6,082; 2014/15: -6,670; 2015/16 (proj): -8,453; 2016/17 (proj): -9,106; 2017/18 (proj): -9,867; 2018/19 (proj): -10,450; 2019/20 (proj): -11,080

### Fiscal performance and public finances
- Fiscal balances (percent of GDP):
  - Total revenue and grants: 2012/13: 19.3; 2013/14: 20.6; 2014/15: 20.8; 2015/16 (proj): 21.9; 2016/17 (proj): 22.0; 2017/18 (proj): 22.2; 2018/19 (proj): 22.4; 2019/20 (proj): 22.5
  - Expenditure: 2012/13: 17.2; 2013/14: 19.1; 2014/15: 19.9; 2015/16 (proj): 24.2; 2016/17 (proj): 24.2; 2017/18 (proj): 23.7; 2018/19 (proj): 22.3; 2019/20 (proj): 22.6
  - Net lending/borrowing: 2012/13: 2.2; 2013/14: 2.4; 2014/15: 1.6; 2015/16 (proj): -2.3; 2016/17 (proj): -2.2; 2017/18 (proj): -1.5; 2018/19 (proj): 0.1; 2019/20 (proj): -0.1
- Budgetary outcomes (in billions of Nepalese rupees; selected):
  - Total revenue and grants: 2012/13: 327; 2013/14: 399; 2014/15: 496; 2015/16 (budget): 443; 2016/17 (proj): 586; 2017/18 (proj): 525; 2018/19 (proj): 601; 2019/20 (proj): 681
  - Total revenue: 2012/13: 296; 2013/14: 357; 2014/15: 423; 2015/16 (budget): 403; 2016/17 (proj): 475; 2017/18 (proj): 458; 2018/19 (proj): 529; 2019/20 (proj): 604
  - Expenditure: 2012/13: 292; 2013/14: 370; 2014/15: 511; 2015/16 (budget): 422; 2016/17 (proj): 693; 2017/18 (proj): 579; 2018/19 (proj): 661; 2019/20 (proj): 725
- Public debt:
  - Public debt (in percent of GDP): 2012/13: 32.3; 2013/14: 28.3; 2014/15: 25.7; 2015/16 (proj): 28.9; 2016/17 (proj): 29.4; 2017/18 (proj): 29.6; 2018/19 (proj): 28.7; 2019/20 (proj): 28.0

### Monetary aggregates, liquidity, and banking
- Monetary aggregates (year-on-year percent change):
  - Broad money: 2012/13: 16.3; 2013/14: 19.1; 2014/15: 19.9; 2015/16 (proj): 12.8; 2016/17 (proj): 15.0; 2017/18 (proj): 15.1
  - Reserve money (levels, end-period, in billions of NRs): 2012/13: 354; 2013/14: 437; 2014/15: 499; 2015/16 (proj): 563; 2016/17 (proj): 646
  - Net foreign assets (NRB, end-period, in billions of NRs): 2012/13: 465; 2013/14: 586; 2014/15: 721; 2015/16 (proj): 766; 2016/17 (proj): 827
- Credit:
  - Domestic credit (year-on-year percent change): 2012/13: 16.9; 2013/14: 13.9; 2014/15: 15.7; 2015/16 (proj): 15.8; 2016/17 (proj): 18.3
  - Private sector credit (year-on-year percent change): 2012/13: 20.2; 2013/14: 18.3; 2014/15: 19.4; 2015/16 (proj): 16.5; 2016/17 (proj): 18.0
- Liquidity management:
  - Banks’ excess reserves increased in recent months until the NRB mopped up NR107 billion through a deposit auction in August (text).
  - Interbank interest rate has ticked up and deposit and lending rates have bottomed out (text).
- Financial soundness indicators (selected, end of fiscal year):
  - Capital fund to risk weighted assets: 2014: 12.0; 2015: 11.9
  - NPLs to total loans: 2014: 2.9; 2015: 2.6
  - Return on equity (ROE): 2014: 24.5; 2015: 28.0
  - Liquid assets to total assets: 2014: 26.2; 2015: 25.5

### Business environment and governance
- Ease of Doing Business:
  - Nepal’s overall ranking improved marginally between 2008 and 2015 (figure).
  - Ease of Doing Business Ranking: South Asia comparisons (figure).
- Competitiveness and constraints:
  - Competitiveness is hampered by inadequate infrastructure (text).
  - Regulatory quality: room for further improvement (text).
  - Labor markets are less efficient than regional peers despite the advantage of a young population (text).
- Governance indicators:
  - Voice and accountability have improved but lagged behind peers (text).
  - Voice and Accountability: South Asia percentile trend shown (figure).

### Social and development indicators (selected)
- Millennium Development Goals (selected indicators):
  - Proportion of population below the national poverty line: earliest 42(90); most recent 23.8(13); 2015 Target 21; Status: Likely
  - Net primary enrollment ratio (percent): earliest 64(90); most recent 95.3 (13); 2015 Target 100; Status: Likely
  - Under-five mortality rate (per 1,000 births): earliest 162(90); most recent 54(11); 2015 Target 54; Status: Achieved
  - Maternal mortality ratio (per 100,000 live births): earliest 850(90); most recent 170 (13); 2015 Target 213; Status: Achieved
  - Proportion of population with access to an improved drinking water source (percent): earliest 46(90); most recent 85 (13); 2015 Target 73; Status: Achieved

### Key projections and baseline scenario highlights
- Growth and inflation projections reiterated:
  - Real GDP: 2015/16: 4.4; 2016/17: 5.4; 2017/18: 3.9; 2018/19: 3.8; 2019/20: 3.8
  - CPI (period average): 2015/16: 8.0; 2016/17: 8.3; 2017/18: 7.7; 2018/19: 7.0; 2019/20: 6.1
- Balance of payments and reserves projected to remain adequate under baseline:
  - Gross official reserves: 2015/16 (proj): 7,320; 2016/17 (proj): 7,594; 2017/18 (proj): 8,003; 2018/19 (proj): 8,548; 2019/20 (proj): 9,138
  - Current account (in percent of GDP): 2015/16 (proj): -2.5; 2016/17 (proj): -1.7; 2017/18 (proj): -1.7; 2018/19 (proj): -1.2; 2019/20 (proj): -0.8

*Source: IMF staff estimates and projections based on data provided by the Nepalese authorities (content unit: _cr15317 - 3.4 percent in 2014/15 due to the earthquake.).*

### Appendix I. Progress in Implementing High-Priority FSAP Recommendations

### Appendix I. Progress in Implementing High-Priority FSAP Recommendations

### Financial Stability
- 1. Refocus monetary policy operations on domestic liquidity management to reduce excess reserves, and especially their volatility, with appropriate burden sharing of costs between the financial system and the budget. Introduce Treasury sterilization bonds.  
  - Responsible Authority: NRB  
  - Time Line*: ST  
  - Progress to date: In process  
  - Progress detail: The NRB has been holding deposit auctions intermittently since August 2014 to reduce banks’ excess liquidity. The introduction of Treasury sterilization bonds is under discussion.

- 2. Undertake a thorough Asset Quality Review (AQR) to identify the extent of problem loans in banks’ balance sheets (with TA support).  
  - Responsible Authority: NRB  
  - Time Line*: ST  
  - Progress to date: Not done  
  - Progress detail: Lack of AQR is largely offset by the special investigations conducted by KPMG (Portugal) in conjunction with NRB supervisors. Reviews conducted in BFIs holding about 64% of total assets.

- 3. Conduct an in-depth review and financial analysis of loan portfolios during bank examinations.  
  - Responsible Authority: NRB  
  - Time Line*: ST/MT  
  - Progress to date: In process  
  - Progress detail: Loan portfolio reviews are performed on-site; the reviews are guided by the outmoded asset classification and loss provisioning guidance. As the supervisors gain experience, it is expected the reviews will be more in-depth.

- 4. Reinforce efforts to address financial infrastructure shortcomings in the Payments System, clearing, credit information, collateral registry, and debt recovery areas.  
  - Responsible Authority: NRB/MOF  
  - Time Line*: ST/MT  
  - Progress to date: In process  
  - Progress detail: NRB established a payment and settlement system department, which will also oversee some of the new products such as mobile banking and branchless banking. Reforms have been identified to strengthen the credit information bureau, the collateral registry and debt recovery areas but action has not yet been taken.

### Financial Sector Oversight
A. Banking Sector

- 5. Redefine supervisory approach by: integrating risk-based off-site and on-site supervision; increasing analytical capacity through training; introducing supervisory management information systems (MIS); developing a dedicated human resources (HR) rotation policy; and streamlining the NRB board participation in operational decisions.  
  - Responsible Authority: NRB  
  - Time Line*: ST/MT  
  - Progress to date: In process / not done  
  - Progress detail: Supported by FIRST-funded TA (FIRST) risk-based supervision (RBS) is being implemented for Class A institutions; and is in preliminary stage for on-site supervision. A complementary off-site RBS component is yet to be developed. A donor is assisting in procurement of MIS, and FIRST aims to support off-site RBS practices. A critical need remains for a dedicated HR policy to hire, train and retain qualified supervisors. No action taken on streamlining the NRB Board’s participation in operational decisions.

- 6. Ensure effective compliance with supervisory directives and guidelines by: performing a thorough follow up of the implementation of supervisory recommendations; proactive, earlier, and stronger corrective actions.  
  - Responsible Authority: NRB  
  - Time Line*: MT  
  - Progress to date: Not done  
  - Progress detail: Corrective and supervisory actions remain largely informal; with PCA having a formal framework. The FIRST project supports the development of programs to ensure compliance.

- 7. Review licensing regulations and policy to strengthen the licensing process and support a consolidation of the sector. Once completed, re-license all Classes A, B, and C banks that meet the new reinforced requirements, with an appropriate phase-in period, into a single-license category.  
  - Responsible Authority: NRB  
  - Time Line*: MT  
  - Progress to date: Under review  
  - Progress detail: NRB has indicated its intent to review the licensing framework; this is supported by the FIRST project. The consolidation of the sector may – in the long run have an impact on the various classes of FI.

- 8. Granting the NRB explicit consolidated supervision powers, amending the legal framework to incorporate a comprehensive definition of related parties and controlling interests.  
  - Responsible Authority: NRB  
  - Time Line*: MT  
  - Progress to date: Not done  
  - Progress detail: Although amended BAFIA and NRB Acts have been submitted to Parliament, it is uncertain if the listed items were addressed.* Introduction of consolidated supervision will be sequenced as appropriate.

B. Non-banking Sector

- 9. Divide the CIT into two separate legal entities, segregating the capital market business, to be placed under the supervision of the Securities Board of Nepal (SEBON), from the pension fund business.  
  - Responsible Authority: MOF/SEBON  
  - Time Line*: ST  
  - Progress to date: In preparation  
  - Progress detail: MOF is preparing a concept report (based on a study trip to India).

- 10. Place the EPF and CIT pension fund business under the joint supervision of the Insurance Board (IB) and NRB.  
  - Responsible Authority: IB/NRB/MOF  
  - Time Line*: MT  
  - Progress to date: Not done  
  - Progress detail: Regulatory and supervisory options are being explored.

- 11. Strengthen the operational independence of the IB and SEBON.  
  - Responsible Authority: SEBON/IB/MOF  
  - Time Line*: ST  
  - Progress to date: Not done  
  - Progress detail: The government is first looking to strengthen the capacity of the IB and the SEBON.

### Crisis Management
- 12. Revise Prompt Corrective Action (PCA) policy to require stronger supervisory action, including designation of problematic status at an earlier stage of capital depletion.  
  - Responsible Authority: NRB  
  - Time Line*: ST  
  - Progress to date: Under consideration  
  - Progress detail: NRB considering including liquidity as a trigger for PCA program. No changes made regarding the designation of problematic status.

- 13. Develop and implement a banking financial institution (BFI) Supervision Enforcement policy that presumes certain enforcement action based on CAMELS ratings.  
  - Responsible Authority: NRB  
  - Time Line*: MT  
  - Progress to date: Not done  
  - Progress detail: As the supervisory reforms are implemented, such an enforcement policy may emerge.

- 14. Revise NRB Act to clarify ELA provisions.  
  - Responsible Authority: NRB/MOF  
  - Time Line*: ST  
  - Progress to date: In preparation  
  - Progress detail: NRB Act Amendments tabled in Parliament.*

- 15. Revise NRB Act to grant it special resolution regime powers.  
  - Responsible Authority: NRB/MOF  
  - Time Line*: ST  
  - Progress to date: In preparation  
  - Progress detail: NRB Act Amendments tabled in Parliament.*

- 16. Establish a national financial crisis coordinating committee comprised of all financial sector, regulatory, and supervisory agencies. Develop each individual agency’s crisis contingency plans and roll up individual agency plans into a national crisis contingency plan.  
  - Responsible Authority: MOF/NRB/IB/SEBON  
  - Time Line*: ST/MT  
  - Progress to date: Not done  
  - Progress detail: A high-level interagency coordination committee meets on an ad hoc basis. It would be important to formalize the mandate of this committee to include the development of a national crisis contingency plan.

- 17. Crisis simulations should be conducted periodically.  
  - Responsible Authority: MOF/NRB/IB/SEBON  
  - Time Line*: MT  
  - Progress to date: Not done  
  - Progress detail: A simulation has not yet been conducted; the authorities are encouraged to conduct crisis simulations after passage of the relevant Acts.

* English versions of the BAFIA and the NRB Acts that have been tabled in Parliament are not available; therefore there is no clarity regarding the efficacy of the proposed text.

*Italic: Appendix I. Progress in Implementing High-Priority FSAP Recommendations (source content)._

### 4.5 percent per annum during 2006-2015; a percentage point higher than achieved during the conflict

### _cr15317 - 4.5 percent per annum during 2006-2015; a percentage point higher than achieved during the conflict

### Economic growth, shocks, and poverty impact
- Nepal’s economy grew at 4.5 percent per annum during 2006-2015; described as a percentage point higher than achieved during the conflict period.
- The September 2015 promulgation of the constitution is expected to return focus to development and raise growth prospects; middle income status by 2030 is described as a possibility if available resources are put to productive use.
- On April 25, a 7.8 magnitude earthquake struck central Nepal, with aftershocks causing:
  - 8,700 deaths
  - some 25,000 injuries
- Estimated poverty impact of the earthquakes in 2015/16:
  - could push an additional 2.5-3.5 percent Nepalese into poverty
  - translates to 700,000-982,000 additional poor directly as a result of the earthquake
- Post-Disaster Needs Assessment (PDNA) (completed June 15) placed:
  - total damages and losses at about US $7 billion
  - reconstruction needs at about US $6.7 billion
- Donor pledges and government budget:
  - Development partners pledged $4.4 billion in aid during the June 2015 International Conference on Nepal’s Reconstruction
  - Government of Nepal announced a reconstruction budget of NPR 91 billion (USD 900 million) in the July 2015 budget speech
  - Modalities for fungibility, usability and expenditure of funds for reconstruction in the 14 worst-affected districts remain unclear pending the functioning of the National Reconstruction Authority

### Policy priorities and investment bottlenecks
- Strategic priorities to rebuild and raise growth:
  - Put available resources to productive use and quickly make good losses from the earthquakes
  - Remove bottlenecks to private and public investment in key growth sectors
- Hydropower potential and status:
  - Estimated potential for hydroelectricity generation: 84,000 MW
  - At least half of that is described as economically viable
  - Currently developed capacity: 746 MW (less than 2 percent of the viable potential)
  - Expected benefits of hydropower development: reduce load-shedding and provide major revenues through exporting electricity to India or China

### World Bank Group (WBG) strategy and support
- WBG strategic shift:
  - From short-term post-conflict assistance toward establishing foundations for increased and inclusive growth
  - New Country Partnership Strategy (CPS) covers FY2014-2018
- CPS pillars and focus areas:
  - Pillar 1: increase economic growth and competitiveness — focus on hydroelectric power generation, enhancing transport connectivity, improving the business environment
  - Pillar 2: increase inclusive growth and shared prosperity — focus on agriculture productivity, equalizing access to health care, skills development, social protection
  - Cross-cutting: improving the effectiveness, efficiency and accountability of public expenditure
- WBG principles: balance risks and rewards, selectivity, flexibility; engage in larger programs with nation-wide impact and consolidate engagement into fewer sectors
- WBG instruments and sectoral roles:
  - IDA: transport, energy, education/skills, health, public expenditure management
  - IFC: hydropower, access to finance, facilitate private investments, promote tourism, support agribusiness
  - IDA and IFC to work together on hydropower development, agriculture, and improving access to finance

### World Bank operational portfolio and responses
- FY15 delivery:
  - Eight projects delivered with total value of IDA US$541 million and TF US$16 million, total delivery US$557 million
- As of end of FY15, Nepal portfolio:
  - 23 Active Investment Projects (including four TF Projects above US$ 5 million)
  - Net commitments: US$ 1,861.58 million
    - IDA net commitments: US$ 1,768.71 million
    - TF net commitments: US$ 92.87 million
  - Undisbursed balance: about US$962.87 million
    - IDA portion undisbursed: US$887.43 million
    - TF portion undisbursed: US$75.44 million
  - Indicates about 52 percent undisbursed balance from net commitments
  - One DPC Project for Financial Sector Stability with net IDA commitments of US$100 million
- Earthquake response:
  - $200 million housing reconstruction project to support rural housing reconstruction of about 20 percent of the houses destroyed in the earthquakes
  - Housing reconstruction identified as the largest single need in the PDNA — roughly half of the total recovery needs of all sectors
  - Bank supporting completion of Government’s Program Operational Manual for housing reconstruction implementation arrangements
- Development Policy Credits (DPCs):
  - DPC1: US$ 30 million signed in June 2013
  - DPC2: preparatory work completed; original planned amount increased by US$ 50 million to a total of US$ 100 million (increase under IDA’s Crisis Response Window)
  - DPC3: expected to be implemented in FY16

### IMF–World Bank collaboration and shared workstreams
- Areas led by the Bank with no direct IMF involvement: social sectors, infrastructure, environment, agriculture
  - Education: support across school education, higher education, and TVET; School Sector Reform Program (SSRP) uses SWAp with GON and 13 development partners (10 pooling resources)
  - Health: support via SWAp since 2004; Second HNP and HIV/AIDS Project; Community Action for Nutrition Project (Sunaula Hazar Din) for under-nutrition and emergency nutrition and sanitation in earthquake-affected areas
  - Infrastructure: roads, bridges (Program-for-Results instrument), rural transport, energy transmission and generation projects (Kabeli Transmission Project, Nepal-India Electricity Transmission and Trade Project, IDA-IFC financed Kabeli-A Hydroelectric Project 37.6 MW, Grid Solar and Energy Efficiency Project 25 MW solar)
  - Agriculture and rural development: Nepal Irrigation and Water Resources Management Project, Modernization of Rani Jamara Kulariya Irrigation Scheme, Agriculture Commercialization and Trade Project, Agriculture Food Security Project (AFSP) in West Nepal
  - Poverty Alleviation Fund (PAF): channels resources to poorest rural groups for infrastructure, employment and income-generating opportunities
- Shared responsibilities and joint support with IMF:
  - Public expenditure analysis and support to develop a credible Medium Term Expenditure Framework (MTEF)
  - Joint Public Expenditure and Financial Accountability (PEFA) Assessment II completed; supports next PFM reform action plan
  - Joint advice to Central Bank of Nepal on financial sector regulation through Development Policy Program (second phase)
  - Joint technical assistance and Debt Sustainability Analysis for debt management and fiscal policy
  - Joint Financial Sector Assessment Program (FSAP) and follow-up development policy operations to address banking sector vulnerabilities (crisis management, bank resolution, deposit insurance)

### IFC activities and private sector engagement
- IFC committed investment portfolio (since resuming operations in 2009) stood at $40 million as of March 4, 2014 across power, transport, banking, microfinance, tourism, and trade finance lines
- IFC investment and mobilization:
  - Invested in 14 projects ($57 million) over FY12-FY13 and 6 projects (~$4 million) in FY14 as of March 4, 2014
  - FY15: mobilized and invested directly US$ 54 Million (Hydropower, Tourism, Agribusiness, Trade finance)
  - FY15 first year mobilizing other funders (Canadian Climate change fund, FMO and GAFSP) for private sector investments
- Advisory services:
  - Expanded from $1.3 million in FY09 (three projects) to $12.8 million as of February 2014 (10 percent of South Asia Portfolio) across 12 projects in Nepal
  - Major programs: Investment Climate Reform Project, payments system and credit bureau strengthening, sustainable energy finance, climate resilient agriculture
  - Pipeline: Nepal hydro sector (IFC/World Bank joint), renewable energy and SME banking scale-up, PPP transaction development
- Strategic priorities aligned with IFC South Asia Strategy pillars: (a) inclusive growth; (b) climate change; (c) regional and global integration
- IFC additionality: longer tenor financing, patient equity capital, crisis response products such as liquidity facilities, global/regional expertise, technical assistance for corporate governance and E&S risk management
- Local currency financing: IFC plans to continue efforts with IDA and GON to create instruments for local currency financing for infrastructure hydropower-projects

### Relations with the Asian Development Bank (ADB)
- ADB lending to Nepal began in 1969; as of 31 December 2014:
  - 167 loans/grants totaling $4,310.3 million (133 sovereign ADF loans $3,433.8 million; 5 non-sovereign loans $52.8 million; 34 ADF grants $823.75 million)
- Nepal Country Partnership Strategy (CPS) 2013–2017: selective focus with bulk of resources to energy, transport, urban infrastructure and services, followed by agriculture and education; five thematic priorities mainstreamed
- Active sovereign ADF portfolio as of 31 December 2014:
  - 39 ADF projects and programs (24 loans $1,253.7 million and 26 grants $502.3 million) with overall net amount $1,756.0 million
- 2014 approved assistance: five projects totaling $325 million in ADF loans (including SASEC Power System Expansion Project $180 million)
- Technical Assistance (as of 31 December 2014):
  - Total approved TA $184.4 million; 26 ongoing TAs amounting to $35.4 million
- Private sector operations:
  - Cumulative approvals in four projects amounted to $58.6 million as of December 2014
  - Major private sector project: 60-MW Khimti Hydropower project (approved 1996)
  - ADB private sector focus: hydropower development for domestic sale and export to India
- Trade Finance Program (TFP) activity:
  - TFP has done over 9,000 transactions supporting over $19 billion in trade and over 4,000 SMEs across the region since 2004
  - In Nepal, TFP supported over $69.7 million in trade through 204 transactions (51 percent co-financed by private sector)
  - In 2014, TFP supported one transaction amounting to $17,187.50; no outstanding guarantees for Nepalese banks at that time

### Statistical issues and data quality (as of October 15, 2015)
- General assessment: Economic and financial data broadly adequate for surveillance with scope for improvement, notably in fiscal data (external financing), more detailed price statistics, and timeliness/quality of balance of payments data
- National accounts:
  - CBS compiles national accounts using 1993 SNA; key estimates include GDP by industry and expenditure categories, gross national income and savings
  - Plans to revise national accounts and update base year from 2000/01 to 2010/11; timing uncertain
  - Quarterly GDP estimates development hampered by staff turnover and source data limitations
- Price statistics:
  - NRB compiles CPI; new CPI series with 2014/15 base year released in October (previous base 2005/06) based on a new household expenditure survey
  - No published core inflation series though underlying data appear available
  - NRB publishes Wholesale Price Index (WPI) with weights based on 1999/2000 (agricultural commodities 49.6 percent, domestic manufactured goods 20.4 percent, imported goods 30 percent)
  - CBS received TA to update/expand Producer Price Index (PPI); current PPI coverage restricted to manufacturing
  - Index of wages and salaries compiled with base year 2004/05
- Government finance statistics:
  - Authorities began compiling in accordance with GFSM 2001 in 2011
  - Budget classification improvements needed (exclude financing transactions from functional classification, distinguish revenue vs transactions in nonfinancial assets, subsidies vs capital payments to enterprises)
  - Treasury Single Account (TSA) rolled out to all 75 districts including Kathmandu
  - Fees collected outside the budget, foreign aid directly paid by donors, operations of extrabudgetary entities and local governments not reported in the annual budget
  - No compilation of government balance sheet in accordance with GFSM 2001
  - Government finance statistics regularly reported for Government Finance Statistics Yearbook but not in the IFS
- Monetary and financial statistics:
  - NRB expanded monthly monetary statistics to include development banks and finance companies and publishes an expanded broad money survey
  - Room for improvement in interest rate reporting: deposit and lending rates of commercial banks not well reported; development banks and finance companies rates not reported
  - Suggestion to report prime lending rate of top 5 commercial banks and average deposit rates of same
  - Data inconsistency: NRB’s claims on other depository corporations (ODCs) not consistent with ODCs’ liabilities to NRB because NRB deposits at ODCs are not separately available
- External sector statistics:
  - NRB compiles BOP statistics conforming to BPM5 with shortcomings: (i) underestimation of imports (and to a lesser extent exports); (ii) significant problems measuring remittances; (iii) incompleteness of foreign grants data; (iv) absence of direct investment data; (v) unrecorded financial flows
  - In February 2015 NRB started reporting international investment position (IIP) data following BPM6
  - NRB participating in JSA project on Improvement of External Sector Statistics (ESS); since 2012 receiving TA in ESS
  - 2013 STA mission noted progress: compilation of IIP, resumed compilation of EDS, improved compilation of direct investment; redesigning International Reporting System (ITRS) and improving surveys for direct investment and trade credit data
  - Overall BOP data quality improved with IMF STA technical assistance and training
- Data standards:
  - Nepal is a General Data Dissemination System (GDDS) participant since May 2001; metadata initially posted May 2001 and last updated January 2009
  - Data ROSC on fiscal transparency published October, 2007
- Table of Common Indicators Required for Surveillance (as of October 15, 2015) — frequency and latest observation dates are listed in the source document for exchange rates, reserves, monetary aggregates, interest rates, CPI, government finance, external accounts, GDP, gross external debt, and IIP

*Statement by the IMF Staff Representative — November 16, 2015*

### 1.      This statement provides an update regarding the disruption to transportation

### _cr15317 - 1.      This statement provides an update regarding the disruption to transportation

### Update on disruption to transportation and fuel supply
- The disruption to transportation and trade routes to and from the southern border started two days after the September 20 promulgation of the new constitution.
- All petroleum products consumed in Nepal are imported from India by truck.
- Oil imports represented 15 percent of Nepal’s total goods imports, amounting to US$1.1 billion or 5.3 percent of GDP in the last fiscal year.
- The Nepal Oil Corporation (NOC) is the sole supplier of petroleum products in Nepal and the India Oil Corporation (IOC) is the NOC’s sole supplier.
- With fuel transports coming to a virtual halt, the NOC announced in late September that only limited amounts of fuel would be supplied for private vehicles to slow the drawdown of Nepal’s limited petroleum reserves.
- On November 9 the NOC announced it would no longer sell fuel for use in private vehicles and would prioritize remaining stock for sales to the security forces.
- On November 10, in response to acute shortages of cooking gas, petrol, diesel and kerosene, Nepal’s Forest Ministry announced it would start to provide firewood as an alternative means of fuel.

### Macroeconomic and humanitarian impacts of the disruption
- Economic activity has been slowing markedly in recent weeks due to the absence of viable short-term alternatives for securing adequate fuel.
- Fuel shortages are affecting delivery of emergency supplies to remote regions affected by the April and May earthquakes and delaying post-earthquake reconstruction.
- The near-term outlook for Nepal’s population is becoming bleak with winter approaching, particularly for those rendered homeless by the earthquakes.
- Humanitarian organizations urgently require fuel to maintain operations and deliver food, warm clothing and shelter materials to high-altitude areas at risk from harsh winter weather.

### Downside risks to the near-term economic outlook
- Media report: following a Cabinet decision on November 9 a written request was sent to the government of India to help end the border problems and ease supply of essential goods.
- If the trade disruption is not resolved soon and comprehensively, it will be increasingly difficult for overall economic activity to catch up and register positive growth in this fiscal year.
- Industrial production and tourism are badly affected by unavailability of fuel and other essential inputs.
- Government revenue, particularly customs revenue, is down considerably; government spending is also down.
- The staff report’s projected rebound of growth to 4.4 percent in 2015/16 (mid-July 2015-mid-July 2016) is predicated on a marked increase in government capital spending and reconstruction activity by the private sector.
- Over the past three years, government capital spending through mid-November averaged only about 6 percent of the total for the fiscal year.
- Authorities had expected capital budget implementation to pick up after the end of the festival season in mid-November.

### Authorities’ statement — recent economic developments and outlook
- Statement dated November 16, 2015 by Marzunisham Omar, Executive Director for Nepal; Pornvipa Tangcharoenmonkong, Alternate Executive Director; and Thomas Benjamin Marcelo, Senior Advisor.
- The earthquakes in April and May 2015 resulted in total damages and losses in production estimated at about US$7 billion, equivalent to nearly one-third of GDP.
- Real GDP averaged 4.5 percent growth in the last five years but grew by only 3.0 percent in 2014/2015 due to the earthquakes.
- Sectors adversely affected include tourism, infrastructure, real estate, agriculture and finance.
- Inflation moderated to 7.2 percent in 2014/2015; headline inflation for the first two months of 2015/2016 (mid-July to mid-September 2015) averaged 7.05 percent.
- Balance of payments surplus reached US$1.43 billion in 2014/2015, from US$1.29 billion in the previous fiscal year, mainly due to a current account surplus supported by sustained overseas remittances.
- Gross foreign exchange reserves were US$8.28 billion as of mid-September 2015, equivalent to more than 11 months of imports of goods and services.
- Authorities earlier projected GDP growth of 6.0 percent for 2015/2016 on account of expected public and private sector investment in reconstruction; prolonged drought and the trade blockade-like situation pose risks to these projections.

### Fiscal policy — priorities and measures
- Authorities agree fiscal policy needs to support post-earthquake reconstruction and medium-term growth through higher public investment.
- A National Reconstruction Authority (NRA) will be established to coordinate rehabilitation and reconstruction activities over the next five years; authorities remain committed to passing a new bill to allow establishment of the NRA.
- On revenue performance: authorities agree on the need to enhance enforcement of tax compliance and strengthen tax administration.
- Given substantial development requirements and available fiscal space, authorities can increase domestic borrowing while putting in place measures to avoid crowding out private investment.
- Budget surplus reflects modest revenue growth and continued underspending; authorities recognize the urgent need to accelerate reconstruction, provide assistance to affected households and businesses, increase priority social spending and improve safety nets.
- In the annual budget for 2015/2016, more than US$8 billion was allocated for reconstruction and development, with US$740 million for the National Reconstruction Fund.
- Budget priorities include agriculture, education, health, tourism, infrastructure development, connectivity and construction of hydroelectric power plants.
- To accelerate capital expenditure authorities will expedite approvals, simplify administrative procedures, redirect budget allocations from unimplemented and slow-moving projects to ongoing and better-performing projects, and prioritize projects with completed feasibility studies and environmental and land acquisition requirements.
- A Public Financial Management (PFM) reform action plan was developed in line with past Fund PFM technical assistance.

### Monetary and exchange rate policy
- Authorities favor an accommodative monetary policy stance to support economic recovery.
- Monetary policy aims in 2015/2016: supporting attainment of GDP growth of 6.0 percent, containing inflation within 8.5 percent, and maintaining foreign exchange reserves equivalent to at least 8 months of imports of goods and services.
- Once economic conditions normalize, authorities will aim to keep inflation close to that of India.
- The exchange rate peg to the Indian rupee will help ensure India’s disinflation gains lead to lower inflation in Nepal; authorities will continue to maintain the peg.
- On liquidity management, the NRB will continue deposit auctions introduced in August 2014 to mop up excess liquidity.
- NRB is studying approaches including the interest rate corridor framework to refine monetary operations and strengthen the monetary transmission mechanism.
- Authorities expressed interest in IMF technical assistance on systemic liquidity management, liquidity forecasting, defining monetary operations and operational modalities.

### Financial sector policy and support measures
- NRB implemented temporary regulatory relief for banks in affected areas to enable continued credit extension: measures cover loan-loss provisioning, loan rescheduling and restructuring, and grace periods for loan repayment.
- NRB helped establish an Economic Rehabilitation Fund to provide refinancing facilities and interest subsidy on loans extended to earthquake-affected areas covering residential construction, agriculture, and tourism.
- Authorities broadly agree with staff recommendations to improve stability and resilience of the financial sector and will implement reforms in line with 2014 FSAP recommendations.
- NRB seeks banking industry consolidation by encouraging mergers through increased paid-up capital requirements; directives issued on buying/selling branches of problem banks and migration to chip-based cards from magnetic strip cards.
- Policies to advance financial inclusion include branching policy outside Kathmandu, interest-free loans to facilitate branch establishment in underserved areas, reinstating branches closed during the conflict period, licensing new microfinance institutions, introducing branchless and mobile banking, and implementing financial literacy and consumer protection initiatives.
- NRB expressed interest in IMF technical assistance to develop a strategic plan to implement 2014 FSAP recommendations on bank licensing and regulation, Nepal Financial Reporting Standard implementation, prudential regulation enhancements, and reformulated corrective and enforcement actions.
- NRB welcomes preliminary findings of the ongoing Safeguards Assessment related to the 2015 Rapid Credit Facility (RCF) disbursement, acknowledging progress in adopting a new accounting system and improving financial reporting practices.
- Authorities will continue reforms to strengthen NRB governance and control frameworks as recommended by the September 2015 safeguards assessment mission, particularly internal and external audit mechanisms, currency and vault operations, and the NRB’s legal framework.

### Structural reforms and development agenda
- Authorities remain committed to implementing the structural reform agenda under Nepal’s 13th Development Plan (2013-2016), aiming to transition Nepal from least developed country status by 2022.
- Structural reforms target removal of major bottlenecks to public and private investment and improvement of competitiveness and the business environment.
- Substantial investments are needed in transport infrastructure to expand connectivity and in energy infrastructure to increase supply through hydroelectric power generation.
- Authorities announced a public-private partnership policy framework to facilitate private sector participation in infrastructure development: roads, bridges, hydroelectric power plants and transmission lines.
- Key legislation prioritized for submission and/or passage includes laws on: (a) foreign investment and technology transfer; (b) unified tax code, revenue leakage control, and central revenue board; (c) foreign exchange regulation, restriction on investments abroad, regulation and supervision of savings and credit cooperatives and microcredit institutions, and social security; and (d) land use law as part of risk and disaster management strengthening.

### Concluding remarks and IMF engagement
- Authorities extend gratitude for humanitarian aid, grants and concessional loans from the international community for rehabilitation and reconstruction.
- Authorities thank the Fund for policy advice, technical assistance and the swift RCF disbursement of SDR 35.65 million, which assisted in addressing balance of payments needs and catalyzing resources for reconstruction.
- Nepal has made important progress in macroeconomic policies and structural reforms; the country is recovering from the April and May earthquakes.
- The new government aims to implement the new constitution and lay foundations for post-earthquake reconstruction and higher, inclusive growth.
- Authorities look forward to continued discussions with the Fund on a comprehensive package of macroeconomic and financial sector policies and structural reforms that could be supported by an Extended Credit Facility.
- Authorities view the Fund’s appointment of a full-time IMF Resident Representative in Nepal as timely and critical to reinforce Fund engagement.

*Source: _cr15317 - 1.      This statement provides an update regarding the disruption to transportation*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15317.pdf_