Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with Nepal
IMF News, February 2, 2006
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- Published: February 2, 2006
Background: macroeconomic performance and outlook
- Real GDP growth averaged 2 percent during 2000/01−2004/05, compared to average real GDP growth of 5 percent in the 1990s.
- Inflation:
- Remained in the low single digits overall.
- Rose to 7¾ percent in mid-October 2005 (12-month basis) due to weak agricultural performance, a VAT rate increase, and partial pass-through of higher international oil prices.
- Fiscal outcomes 2004/05:
- VAT rate raised from 10 percent to 13 percent in early-2005, helping raise revenue by ¾ percentage point of GDP to 13 percent of GDP.
- Revenue fell short of the revised budget target due to weaker growth and imports, excise leakages, and delayed excise duty refunds from India.
- Current spending lower than revised budget; higher civil service wages and security-related expenditures offset by lower development and social sector spending in conflict-affected areas.
- Overall deficit: 1 percent of GDP (budgeted 2½ percent of GDP).
- Domestically financed deficit: ½ percent of GDP.
- Monetary and exchange rate policy:
- Policies geared to supporting the exchange rate peg to the Indian rupee.
- Broad money growth slowed from 12¾ percent in 2003/04 to 8 percent in 2004/05.
- Private sector credit grew by 13¼ percent, mainly in consumer lending.
- Liquidity ample; T-bill rates remained low; interest rates edged lower.
- Balance of payments and international reserves:
- Total exports rose by 10 percent in 2004/05; exports to India rose by 30 percent; exports to other countries declined by over 15 percent.
- Total import growth stagnant; oil imports up 35 percent; non-oil imports down 6 percent.
- Current account surplus (excluding official transfers) increased from 1 percent of GDP in 2003/04 to 3 percent of GDP in 2004/05.
- International reserves increased to around US$1.5 billion (7¾ months of imports of goods and services) at end-2004/05.
- Financial sector and banking reforms:
- External management teams at NBL and RBB (accounting for 50 percent of banking system deposits) turned banks from loss-making in 2000/01 to profits in 2003/04 and 2004/05.
- Management and credit evaluation practices improved; ADB-supported restructuring of Agricultural Development Bank of Nepal proceeded well.
- Nepal Industrial Development Corporation financial condition remains dismal.
- Non-performing assets share in NBL and RBB remains high; recoveries from large, willful and politically-connected defaulters limited.
- Debt Recovery Tribunal limited by staff and capacity constraints.
- Debt recording and arrears:
- Nepal provided inaccurate information related to the second disbursement made in November 2004 under the PRGF arrangement due to weaknesses in its debt recording system; the disbursement was noncomplying.
- Accumulated external payment arrears to Austria occurred between November 2003 and October 2004.
- Corrective actions taken and the arrears cleared.
Growth scenarios and risks
- Staff projection for 2005/06: real GDP growth of 2½−3½ percent.
- Upside scenario (requires political stability, improved security, and structural reforms):
- Gradual return to growth rates of 5−5½ percent through 2009/10.
- Rebound in manufacturing and services, higher tourism earnings, larger contributions from agriculture and government activity.
- With the peg, inflation expected to broadly follow price developments in India.
- Export growth projected to average 8 percent assuming further diversification beyond traditional sectors.
- Imports (oil and non-oil) projected to pick up with economic activity.
- International reserves projected to remain around 6−7 months of imports of goods and services.
- Downside scenario (if conflict persists and reforms stall):
- Low growth rates could become entrenched, security-related spending pressures would remain high, development spending low.
- Fiscal and external positions could deteriorate and international reserves could be lower.
- Key risks:
- Slow reform implementation jeopardizing external assistance.
- Higher global oil prices.
Executive Board assessment: main findings and policy recommendations
- Overall assessment:
- Nepal at a critical juncture; political uncertainties and the insurgency dampen economic growth.
- Resolving political uncertainties, improving security, and progress toward peace are essential for poverty reduction and private sector led growth.
- Macroeconomic stability and PRSP:
- Directors commended maintenance of macroeconomic stability under difficult conditions and progress in reform implementation until mid-2004.
- Encouraged reinvigoration of policies in Nepal's Poverty Reduction Strategy Paper (PRSP) to address constraints on growth, maintain stability, reduce poverty, and mobilize external assistance (PRGF, donor programs, HIPC Initiative, Multilateral Debt Relief Initiative).
- Fiscal policy recommendations:
- Commended revenue mobilization, expenditure prioritization, increased social sector spending, and limiting domestic budget financing.
- Encourage further tax administration improvements to raise collection levels.
- Concern over high security-related spending and low development spending relative to budgets, especially in conflict-affected areas.
- Encourage raising spending on infrastructure and social sector projects while limiting domestically financed deficits consistent with medium-term fiscal sustainability.
- Favor early implementation of an automatic pricing mechanism for petroleum products to improve Nepal Oil Corporation finances.
- Emphasized need to increase fiscal transparency, improve public expenditure management, and implement fiscal ROSC recommendations, including broader coverage of off-budget activities and more comprehensive reporting of security-related spending.
- Exchange rate:
- Agreement that the peg to the Indian rupee remains appropriate; peg helps keep inflation low and leverages close ties with India.
- Level of peg should be kept under review given growing integration in the world economy (WTO and regional arrangements).
- External competitiveness should be raised via structural reforms and infrastructure investments to lower transactions and transportation costs.
- Financial sector and public enterprise reform:
- Commended progress in financial sector reforms; more needed.
- Welcome measures to improve debt recovery, raise NRB efficiency, and restructure commercial and development banks.
- Legal framework can be further improved through amendments to the Banking and Financial Institutions Ordinance.
- Encourage NRB to enhance financial sector supervision and raise internal audit and accounting standards.
- Significant loan recoveries from large, willful defaulters required to improve bank balance sheets.
- Delay in restructuring Nepal Industrial Development Corporation should be addressed by prompt and transparent privatization.
- Accelerate public enterprise and governance reforms; liquidate unviable loss-making enterprises; use share sales and management contracts to improve efficiency.
- Welcome adoption of the Civil Service Ordinance and urge early promulgation of the Governance Ordinance.
- Anti-corruption efforts should focus on large, prominent offenders.
- Labor, business environment, and agriculture:
- Encourage enabling environment for private sector: upgrade regulatory framework and make labor markets more flexible.
- Welcome promulgation of the Secured Transactions, Company, Securities, and Insolvency Ordinances; urge early promulgation of the draft Labor Ordinance.
- Given importance of agriculture and rural poverty, encourage implementation of Agricultural Perspective Plan policies to raise agricultural productivity through complementary inputs, improved rural infrastructure, commercialization, and market access.
- Remittances and AML/CFT:
- Encourage facilitation of remittances through formal channels by reducing transaction costs and redirecting remittances toward investment and employment creation.
- Call for implementation of a strong anti-money laundering and combating the financing of terrorism (AML/CFT) regime.
- Arrears and data:
- Regret misreporting of external payment arrears under the PRGF second disbursement; welcome clearance of arrears and efforts to strengthen external debt management.
- With corrective actions, Directors approved a waiver for Nepal's nonobservance of the performance criterion on the nonaccumulation of external payment arrears.
- Stress need to address data deficiencies and urge full implementation of Fund technical assistance recommendations.
Selected economic indicators (highlights, 2000/01–2004/05)
- Output and prices (percent change):
- Change in real GDP: 5.6; -0.6; 3.4; 2.5.
- Change in CPI (end-period): 3.5; 6.1; 2.0; 6.6.
- Budgetary operations (percent of GDP):
- Total revenue: 11.4; 11.5; 12.3; 12.2; 13.0.
- Total expenditure: 17.5; 17.2; 16.0; 15.5.
- Current expenditure: 11.1; 11.2; 11.7.
- Capital expenditure and net lending: 6.4; 4.6; 4.3.
- Overall deficit (after grants): 4.5; 1.6; 1.0; 0.9.
- Money and credit:
- Broad money: 15.2; 4.4; 9.8; 12.7; 8.0.
- Domestic credit: 18.8; 9.2; 12.0; 9.3; 13.3.
- External sector (in millions of U.S. dollars, unless otherwise indicated):
- Exports, f.o.b.: 945; 754; 653; 748; 826.
- Imports, f.o.b.: 1,710; 1,448; 1,556; 1,801; 1,806.
- Current account (excluding grants): 162; 106; 16; 59; 226.
- Overall balance: 38; -39; 93; 235; 24.
- Gross official reserves: 1,020; 1,048; 1,178; 1,471; 1,507.
- Rupees per U.S. dollar (end-period): 74.7; 78.0; 74.8; 74.1; 70.0.
Public Information Notice (PIN) No. 06/12 — February 2, 2006.