On behalf of our Nepal authorities, we would like to thank the Managing Director for her commitment in supporting the recovery and reconstruction of Nepal following the devastating earthquakes in April and May 2015. We would also like to commend the staff for their prompt response and hard work in order to bring for the Board’s consideration the request of Nepal for access under the Rapid Credit Facility (RCF) of the Poverty Reduction and Growth Trust (PRGT). The authorities are very much appreciative of the Fund’s policy advice and technical assistance in key areas as well as the catalytic role that the Fund is playing in mobilizing support for Nepal.
The authorities strongly appreciate the outpourings of support received from the international community in response to the devastating earthquakes. This includes the swift and continuing provision of humanitarian aid by several countries and organizations. The authorities welcome the generous pledges by bilateral and multilateral donors of about US$4 billion in grants and concessional loans for the reconstruction efforts to be disbursed over a period of five years, as announced at the International Conference on Nepal’s Reconstruction on 25 June 2015. The authorities reaffirm their commitment to ensure the effective use of these financial resources for the rehabilitation and reconstruction efforts.
Damage Assessment and Economic Outlook
An earthquake on April 25 and a powerful aftershock on May 12 devastated Nepal, resulting in extensive damage to two-thirds of the country’s districts, particularly in the central and western parts of the country. More than 8,800 people lost their lives and more than 22,300 people were injured. Over half a million houses were destroyed and another quarter million was damaged, rendering three million people homeless. Around half a million buildings were also destroyed. The authorities estimate that an additional 3 percent of Nepal’s population, as many as a million people, has been pushed into poverty as a direct result of the earthquakes, on top of the 25 percent who were estimated to already be living below the poverty line.
The total value of damages and losses in production are estimated at about US$7 billion, equivalent to nearly one-third of the country’s GDP. The earthquakes are expected to result in an initial slowdown in economic activity and will strain Nepal’s external position. As such, the disaster has set back efforts to further develop the economy and enable Nepal to graduate from least developed country status.
The economic growth rate of Nepal over the past five years averaged 4.5 percent. This year, the economy was initially projected to grow at 5.2 percent compared to the growth of 3.5 percent last year. The damage to property has adversely affected productive capacity. Further, the devastation caused by the earthquakes has particularly affected the agriculture and tourism sectors, and the growth outlook in 2014/2015 has been revised downwards to 3.04 percent, the lowest in eight years. The growth recovery will largely be determined by the vigor of the reconstruction effort. The authorities expect GDP growth to register 6 percent in 2015/2016 on account of the significant public and private sector investments in reconstruction and expansion in economic activities.
Inflation, which has averaged 9.3 percent in the past five years, had moderated to less than 7.5 percent in the eleven months of 2014/2015. Inflationary pressures are expected to build up on account of supply-side bottlenecks, an expansionary budget to finance reconstruction efforts, and upward pressure on wages of both skilled and unskilled workers. However, the authorities expect that inflation will be contained to a single digit.
Fiscal deficit is expected to emerge as revenues fall and expenditures rise reflecting efforts by authorities to provide assistance to earthquake-affected businesses and households, including vulnerable groups in the short-term, while supporting the reconstruction efforts.
The fall in foreign exchange receipts from exports and tourism and increased imports of reconstruction-related goods are expected to push the current account into deficit. This will strain Nepal’s external position and the pace of public sector reconstruction will importantly depend on the amount of external financing that Nepal receives to rebuild. The authorities expect that without the mobilization of substantial grants and concessional loans, foreign reserves would decline significantly over the medium term even as they expect an increase in workers’ remittances to support their families.
Request for Financial Assistance
The authorities would like to request for financial assistance under the RCF to address Nepal’s urgent balance of payments need and mitigate the risks of economic disruption as reconstruction activity gets under way. The assistance would be a disbursement of SDR35.65 million (approximately US$50 million) under the RCF to ease the pressure on Nepal’s fiscal resources and foreign exchange reserves. The authorities are requesting for the funds to be disbursed as budget support to the account of the Ministry of Finance at the Nepal Rastra Bank (NRB). The IMF’s involvement is also expected to help catalyze further donor support for the reconstruction efforts.
Fiscal Policy. The Nepal authorities have established the National Reconstruction Authority under the leadership of the Prime Minister to coordinate the swift and efficient implementation of rehabilitation and reconstruction activities in the next five years. The authorities recently unveiled the annual budget for 2015/2016, and allocated more than US$8 billion for reconstruction and development. Based on the annual budget, the authorities have allocated US$740 million to the National Reconstruction Fund. In addition to the reconstruction efforts, the authorities have prioritized budget allocation to agriculture, education, health, tourism, infrastructure development, connectivity and the construction of hydroelectric power plants.
The authorities welcome the debt sustainability analysis, which highlights that Nepal’s risk of debt distress continues to remain low, underpinned by prudent debt management and fiscal policy. They acknowledge the urgency to accelerate public investment in the aftermath of the earthquakes. The authorities reaffirm their commitment to a prudent borrowing policy and will seek external grants and concessional loans to finance the reconstruction efforts and put the economy on a path of higher growth and faster poverty reduction.
The authorities will also strengthen public financial management to accelerate capital expenditure through improved budget planning, project selection, implementation and results monitoring. In particular, budget allocation for unimplemented and slow moving projects will be realigned to ongoing and better performing programs and projects. Projects that have detailed feasibility studies and whose environmental assessment and land acquisition requirements have been completed will be prioritized for implementation. The authorities have also allocated funds for project development. They are also introducing changes to the procurement law to fast track public procurement and facilitate project implementation. The authorities appreciate the technical assistance provided by the Fund in public financial management and will consider the recommendations to further improve Nepal’s arrangements for capital budget management.
Monetary Policy. The Nepal authorities have adopted a cautious and balanced stance of monetary policy to support economic recovery as well as to contain inflationary pressure expected to arise from fiscal expansion.
Given the economic disruption, some increase in inflation is inevitable. Once economic conditions normalize, the authorities will aim to keep inflation close to that in India. The authorities will continue to maintain a pegged exchange rate to the Indian rupee, which has served well in minimizing market volatility.
Financial Sector Policy. To help ease the impact of the devastating earthquakes, the NRB has put in place regulatory relief for banks in the affected areas, so that the banks could extend the same to their customers. Among others, the temporary relief measures covers loan-loss provisioning and loan rescheduling. The NRB also waived approval to open a branch and launch mobile and branchless banking in the market center of selected earthquake-affected areas. An Economic and Rehabilitation Fund was also established under the NRB, to provide a refinancing facility and interest subsidy on loans extended to earthquake-affected areas covering residential construction, agriculture, business and tourism development.
Even before the earthquakes, the authorities were cognizant of the importance of financial inclusion and have pursued various policies and programs to improve access to financial services. These policies and programs include among others, branching policy outside of Kathmandu, provision of interest-free loans to facilitate the establishment of branches in underserved areas, introduction of branchless banking and mobile banking, and implementation of financial literacy and financial consumer protection initiatives. The authorities recently announced a nationwide campaign to encourage households to open at least one bank account by ensuring that cash transfers by the government will only be done through bank accounts.
The authorities will likewise continue to implement the financial sector reform program to strengthen the legal framework and institutional capacity for bank supervision and regulation and for financial crisis management and bank resolution.
Structural Reforms. The authorities are determined to implement its ambitious structural reform agenda under Nepal’s 13th Development Plan (2013-2016), which aims at graduating from least developed country status by 2022. The authorities are undertaking the necessary structural reforms to improve competitiveness and the business environment. The authorities have identified as priority areas, infrastructure, especially transportation and energy, education and training, increasing SME access to finance, and strengthening social safety nets. The authorities acknowledge the importance of public-private partnerships in addressing the infrastructure gaps, particularly in increasing energy supply through hydroelectric power generation.
The Nepal authorities would like to reiterate their gratitude to staff for their productive engagement on policy and the speed and flexibility of their response in the aftermath of the earthquakes. The authorities have found the discussions productive, are grateful for the insightful analysis provided by staff, and will closely consider all aspects of the Fund’s policy advice. The authorities are committed to undergo an update of the Safeguards Assessment undertaken by the Fund in 2011 in connection with the 2010 RCF disbursement. This will provide an opportunity to further examine the external audit mechanism and financial reporting framework of the NRB.
The Nepal authorities look forward to the Board’s approval of a disbursement under the Rapid Credit Facility of the PRGT. This will assist the authorities in the enormous task of catalyzing further resources for rehabilitation and reconstruction. The appointment of a full-time IMF Resident Representative in Nepal to reinforce the effectiveness of the Fund’s engagement with Nepal will likewise be much appreciated.
The authorities consent to the publication of the staff report and the Letter of Intent.