Statement by Dono Iskandar Djojosubroto, Executive Director and Madhav Prasad Bhatta, Advisor to the Executive Director for Nepal

This 2002 Article IV Consultation highlights that Nepal’s real GDP growth is estimated to have slowed to 0.8 percent in 2001/02 from 5 percent in the previous year (fiscal year ending mid-July). Agricultural growth slowed to less than 2 percent from more than 4 percent, reflecting irregular rainfall. The output of nonagricultural sectors was largely stagnant, with manufacturing and tourism sectors particularly hit hard by the domestic security situation as well as the global slowdown. Inflation was subdued at about 3 percent, reflecting weak domestic demand and stable Indian prices for most of the year.

Abstract

This 2002 Article IV Consultation highlights that Nepal’s real GDP growth is estimated to have slowed to 0.8 percent in 2001/02 from 5 percent in the previous year (fiscal year ending mid-July). Agricultural growth slowed to less than 2 percent from more than 4 percent, reflecting irregular rainfall. The output of nonagricultural sectors was largely stagnant, with manufacturing and tourism sectors particularly hit hard by the domestic security situation as well as the global slowdown. Inflation was subdued at about 3 percent, reflecting weak domestic demand and stable Indian prices for most of the year.

On behalf of the Nepalese authorities, we would like to thank staff for a comprehensive and analytical report on the recent economic developments in Nepal. The observations and suggestions put forward by the staff would be most useful in guiding the authorities’ design of policy initiatives to meet the socioeconomic challenges faced by Nepal.

Macroeconomic Performance

The Nepalese economy, which had achieved encouraging macroeconomic performance during the last few years, faced a setback in fiscal year 2001/02 because of the adverse domestic and external situation. Real GDP growth is estimated to have declined to 0.8 percent in 2001/02 from 4.9 percent in the previous year. The poor economic performance is attributed to the deterioration in the peace and security situation in the country, coupled with the events of September 11 that had significantly affected the tourism and manufacturing sectors. In addition, the delayed arrival of the monsoon season and the fall in prices of agricultural products affected the performance of the agricultural sector. Growth of the non-agricultural sector was only marginal owing to the negative growth of the manufacturing, trading and tourism sectors.

The growth of monetary aggregates further decelerated in 2001/02 from the preceding year’s level. The growth of broad money fell from 15.2 percent in 2000/2001 to 5.5 percent in 2001/02. Similarly, credit to the private sector increased by only 5.9 percent compared with 15.8 percent the year before. However, as in the last two fiscal years, inflation remained subdued with the consumer price index rising by 2.9 percent in 2001/02 compared with 2.4 percent in the previous year.

The external sector which was already weak with decelerating export growth and declining service receipts, continued to deteriorate in 2001/02. Exports declined by 14.6 percent in 2001/02 against a growth of 11.7 percent in 2000/01. This was largely attributed to a significant fall in garment and carpet exports as well as the introduction of non-tariff barriers on Nepal’s concessional exports by India. At the same time, the slowdown in economic activities and weak export prospects suppressed the demand for both consumer and capital goods, resulting in a 7.7 percent decline in imports.

The overall balance of payments fell into a deficit of 0.6 percent of GDP in 2001/02 after registering surpluses in previous years owing to a sharp decline in services receipts and lower capital inflows. Despite this, gross official international reserves remained high, covering more than 8 months of imports.

Despite Nepal’s high dependence on external resources to finance the government budget, its external debt remains manageable. Total external debt stood at 48.4 percent of GDP in 2001/02, approximately similar to the preceding year. However, due to limited domestic resources, the external debt servicing has increased to 13 percent of total revenue or 13.4 percent of regular government expenditures in 2001/02.

The fiscal situation continued to be under stress as a result of the high expenditure for security needs and the weaker revenue performance attributed to the economic slowdown. The budget deficit, however, narrowed to 5.4 percent of GDP in 2001/02 compared with 5.9 percent in the preceding year

Reform Initiatives

The Nepalese authorities have set “poverty reduction” as its foremost development objective. The Tenth Plan and the policies outlined in the budget speech for the current fiscal year will address this goal despite the emergence of obstacles in the areas of peace and security. The authorities’ poverty alleviation programs for the current fiscal year have focused on achieving a broad-based, sustainable and high economic growth, improved quality of social services, development of infrastructure, population management and empowerment, and the protection and creation of income generating opportunities for people living below the poverty line as well as the disabled. The government is finalizing the Tenth Plan along with the Poverty Reduction Strategy Paper (PRSP).

Expenditure Reforms

A number of reform measures have been introduced towards fiscal consolidation. The Medium Term Expenditure Framework (MTEF) has been adopted to further rationalize resources and prioritize programs as reflected in the current year’s budget. Despite resource constraints, the authorities have allocated necessary funds to programs for the priority sectors and those that will directly benefit the general population. The cabinet has also approved a new policy on foreign aid that sets out the objective of using foreign assistance mainly in the priority areas.

The authorities have also formulated an Immediate Action Plan (IAP) that will prioritize public resources to provide immediate relief to the population and reduce poverty. The TAP also aims to improve the quality of public services and enhance transparency and accountability. The government has also constituted a committee comprising representatives from the Ministry of Finance, the National Planning Commission, and the Office of the Prime Minister to monitor its implementation and to review progress on a regular basis.

To support the authorities’ poverty reduction objectives, a poverty-based formula for allocation of block grants among the local bodies is being developed. The authorities have encouraged greater participation from the community in the areas of education and health services to improve the quality of service delivery. The authorities have also set aside resources to rehabilitate of ailing industries in order to revive the manufacturing sector. They have also decided to grant 10-year multiple entry visas to non-residents of Nepalese origin to attract foreign investments.

However, at the top of the authorities’ agenda is the need to restore peace and security in the country. For this purpose, the security agencies have been provided with the required resources to conduct their operations effectively.

Revenue Reforms

A new Income Tax Act that would widen the income tax net has been introduced while the VAT has been made more effective through rationalization measures. With the widening of the income tax net, revenue administration has also been strengthened. In this regard, laws and by-laws governing revenue administration and its organizational structure have been reviewed and simplified. A code of conduct for revenue officials has been introduced. To enhance the integrity of revenue officials, a staff transfer policy has been worked out while guidelines for the entry into and exit from the tax collection service is being considered.

Civil Services Reforms

The civil service is being reformed to make it more result oriented with greater responsibility and accountability for policy formulation and program implementation. In this regard, necessary reform measures, including downsizing the civil service, outsourcing of support services and freezing of vacant positions are being implemented. In addition, the compensation policy, contributory pension system and voluntary retirement schemes are being revised.

Corruption Control

The authorities have introduced a new Anti-Corruption Act with enhanced powers being granted to the anti-corruption agency in order to curb corruption and promote good governance. Soon after the new Act came into effect, the Commission for the Investigation of the Abuse of Authority (CIAA) has begun investigating the sources of income of two dozen revenue officials. This was seen as a positive start towards the authorities’ efforts to tackle corruption in the country. A high level Property Investigation Commission was also constituted a few months ago to scrutinize the assets of more than 30,000 existing and retired public officials.

Financial Sector Reforms

With the assistance from the World Bank, the authorities have proceeded to make progress in financial sector reforms to restructure the ailing public sector banks. The management of one of the two largest public sector commercial banks, the Nepal Bank Limited, has been transferred to an external management team while that of the other bank, the Rastriya Banijya Bank, will be transferred to a new management team within the first four months of the current fiscal year. Necessary amendments in the financial sector regulations have been made and the new Nepal Rastra Bank (the central bank) Act has come into effect from the beginning of 2002. The Act provides the central bank with greater autonomy for its operations, including the formulation and implementation of monetary and exchange rate policies. It also sets out a clear and transparent procedure for the appointment and dismissal of the Governor and Deputy Governors.

A new umbrella act for banks and financial institutions is in the process of being enacted to establish a uniform regulatory system for all deposit taking institutions and finance companies. Nepal Rastra Bank (NRB) will be establishing an Asset Management Company this fiscal year. It also plans to issue new directives to strengthen the Credit Information Bureau. Nepal has become a member of the Asia/Pacific Group (APG) on Money Laundering with effect from March 1, 2002. An Anti Money Laundering Act has been drafted and will be submitted to the new parliament. As a member of the APG, Nepal is committed to establish an anti-money laundering regime that is consistent with the 40 recommendations of FATF.

The central bank has also initiated a number of other reforms like the withdrawal of NRB officials from the boards of commercial banks, phasing-out the priority sector credit program, and withdrawal of the maximum interest rate spread. The commercial banks’ cash reserve requirements was also reduced to provide additional liquidity to the market to stimulate economic growth. All these reforms are expected to generate greater dynamism in the banking and financial sector and improve the investment climate in the country.

External Sector Reforms

Nepal is preparing for accession to the WTO and in this regard, its external sector is being liberalized further. The Foreign Exchange (Regulation) Act has been comprehensively amended to incorporate the liberalization measures introduced so far. Nepal adheres to the obligations of Article VIII and would further liberalize its foreign exchange regime as required. However, as convertibility of the capital account has not been established, it would not be feasible to allow unlimited access to foreign exchange, bearing in mind that there is already full convertibility of Nepalese rupees into Indian rupees. Given the low-income levels of the average Nepali, the existing limit on the foreign exchange facility for personal travel abroad (the so called Passport facility) has not been a hindrance to Nepalese traveling abroad. For those traveling for reasons such as business, education, training, medical treatment etc. are able to obtain the required amount of foreign exchange. Regarding the exchange rate regime, Nepal will continue to maintain a fixed exchange rate with the Indian currency, as the country has benefited from such an arrangement.

PRGF Issues

The Nepalese authorities have met most of the conditions for the proposed entry into a PRGF program with the Fund. The finalization of the Tenth Plan along with the Poverty Reduction Strategy Paper (PRSP) and the adoption of the Medium Term Expenditure Framework (MTEF) to further rationalize both resources and programs are the latest developments in this regard. Nepal’s macro-economic indicators are also broadly on track. Despite its resource constraints, net domestic borrowing of the government has been maintained at about 2 percent of GDP. Monetary discipline has enforced, with money supply growth contained at the desired level. Inflation is well under control and despite the adverse external environment, foreign exchange reserves are at a comfortable level to absorb any external shocks. However, a number of unexpected obstacles, particularly due to the deteriorating peace and security situation and the unstable political environment, have delayed some of the structural reform efforts. The Nepalese authorities are making their best efforts to overcome these obstacles and expect to enter into the PRGF arrangement with the Fund as soon as possible.

Statistical Issues

The Nepalese authorities would like to acknowledge the technical assistance provided by the Fund in the various statistical areas. These had benefited the authorities greatly. Following the recommendations of the technical assistance missions, Nepal has introduced a large number of reforms in the area of money and banking and balance of payments statistics. The multi-sector statistics mission has also been useful and Nepal is already participating in the framework of the General Data Dissemination System (GDDS) for the compilation and dissemination of macroeconomic and socio-demographic data. The Nepalese authorities look forward to receiving continued technical assistance from the Fund in the future.

Conclusion

The major challenges facing Nepal are the issues of insecurity and poverty. Parliamentary elections will be held in November this year. The new government is expected to continue on the path of reforms and will expedite the reform efforts in order to reach an agreement with the Fund for a PRGF program that will address the challenges of poverty reduction. However, the authorities recognize that the challenge of reducing poverty in Nepal cannot be met solely by its own resources. Therefore, the authorities need the financial and technical support of the international community in their efforts to reduce poverty.