IMF Concludes Staff Visit to Nepal

IMF News, October 4, 2013

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An IMF staff team led by Mr. Alexander Pitt visited Kathmandu during September 26-October 3, 2013, to assess recent macroeconomic developments and progress on key reforms in the financial sector, public financial management, and tax administration.
The mission held discussions with Finance Minister Koirala, Nepal Rastra Bank Governor Khatiwada, National Planning Commission Vice Chairman Shakya, Finance Secretary Subedi, and other senior officials, and met with private sector representatives and development partners.

Growth decelerated in 2012/13 due to weak agricultural activity and the delayed approval of the budget, which impeded capital expenditure and, together with strong revenue growth, led to a fiscal surplus.
Inflation slowed to 7.7 percent (y/y) in July 2013, but has since begun to increase, in part owing to pass through effects derived from the exchange rate peg to the depreciating Indian rupee.
Sustained growth in remittances led to a balance of payments surplus.
Private sector credit growth accelerated, in part due to increased lending to priority sectors.

Growth is expected to recover somewhat in the near term, boosted by:
- a favorable monsoon,
- timely approval of the 2013/14 budget,
- measures to expedite capital spending.
Inflation pressures are rising due to the depreciation of the Nepalese rupee and continued strong credit growth.
Growth of remittances—from a high base—is expected to moderate but remain strong.
International reserves should continue to rise, though at a slower pace.

Major risks stem from developments in India, Nepal’s key trading partner:
- In the near-term, the rupee depreciation is raising price pressures, and exacerbating the already high losses of the state-owned Nepal Oil Corporation (NOC).
- Financial sector risks have increased.
- A protracted slowdown in India is likely to have adverse effects on growth.

The mission notes that the exchange rate peg with the Indian rupee serves as a useful nominal anchor, and welcomes the authorities’ decision to maintain it.
The peg continues to benefit Nepal in view of its close economic relationship with India.
The recent depreciation creates an opportunity to benefit from enhanced international competitiveness, which would be boosted by structural measures to lower the cost of doing business.

Monetary policy:
- Monetary conditions should be tightened to lock in the recent decline in inflation, and reduce the gap with interest rates in India.
- Tighter monetary policy in India and excess liquidity in Nepal have widened the gap in money market interest rates, which could increase financial sector vulnerabilities.
Fiscal policy:
- Fiscal policy needs to support growth and poverty reduction, especially through much-needed capital expenditure.
- The mission welcomes the timely budget and rapid approval of public investment projects.
- Further efforts to expedite capital expenditure over the course of the year and avoid year-end bunching should be considered.

NOC losses need to be urgently addressed to free up resources for investment and social spending.
The mission welcomes the recent adjustment of fuel prices, and encourages the authorities to implement further price increases, ideally through an automatic price adjustment mechanism to avoid recurrent losses, which ultimately have to be financed by the government.

Financial sector reforms need to be pushed forward.
While financial sector health has improved, the mission considers that risks are still significant:
- Asset quality remains a concern.
- Connected lending and conflicts of interest are widespread.
- The fragmentation of the banking system makes supervision difficult.

The IMF will continue to provide intensive support for Nepal’s reform efforts in:
- banking regulation and supervision,
- anti-money laundering,
- crisis management,
- tax administration,
- tax policy,
- expenditure reform including for pensions.
The regular Article IV consultation visit is expected to take place in April or May of 2014, following a joint World Bank – IMF financial sector assessment scheduled for November 2013–February 2014.

IMF Press Release No. 13/385, October 4, 2013.