Abstract
KEY ISSUESContext: Successful elections for a new Constituent Assembly and formation of a new government have stabilized the political situation.Macroeconomic situation and outlook: Nepal’s macroeconomic situation remains broadly favorable. Growth is projected to recover in 2013/14 owing to good monsoons, robust growth in services, and increased public spending. Inflation is moderating, in line with developments in India. High remittance inflows are supporting a strong external position, as well as high reserve money growth. Risks to the outlook are slightly tilted to the downside, involving slower-than-expected growth in countries hosting Nepali workers and domestic financial sector risks.Medium term prospects: While remittances are expected to continue to support the external position, the outlook for growth depends on improving the environment for private investment. This requires a decisive boost in public capital spending, and structural reforms in key areas.Financial sector: Despite progress, significant vulnerabilities remain. The recent assessment under the FSAP, Nepal’s first, raised concerns about asset quality and interconnectedness, as well as financial sector infrastructure—including the legal framework—and supervision and crisis preparedness. At the same time, a largely unsupervised cooperatives sector is growing rapidly.Key policy recommendations: Monetary policy should aim at controlling the volatility and level of excess reserves in the financial system, implying a modest tightening of monetary conditions. The exchange rate peg to the Indian rupee provides a useful nominal anchor for the economy, and the real exchange rate is broadly in line with fundamentals. Capital spending needs to be boosted to provide key infrastructure, and reforms implemented to support private investment, which will help generate sustained economic growth and employment opportunities. In the financial sector, further reforms to bolster regulation and supervision, and improve financial infrastructure are needed to reduce risk and increase access to finance.
This statement summarizes the main developments since the staff report was issued on June 18, 2014. This information does not alter the staff’s assessment of policy issues and the thrust of recommendations contained in the staff report.
The latest available data suggest that CPI inflation in Nepal rose to 9.7 percent (year on year) in May, in large part due to weather-related food price hikes. This development broadly resonates with CPI inflation in India, consistent with the findings of staff analysis that inflation in Nepal is closely related to Indian inflation (see Box 3 in the Nepal staff report). The latest CPI inflation rate in India was 8.3 percent (year on year) in May.
External sector developments are broadly in line with projections in the staff report. Growth of remittances has slowed to 14.5 percent in May (year on year, year to date). International reserves reached $6.1 billion at end-May, with reserve cover at 8.2 months of prospective imports.
Reserve money growth remained broadly stable, reaching 28.4 percent in May (year on year). Excess reserves in the banking system, after declining earlier in the year, rose again to NRs 54 billion, despite efforts by Nepal Rastra Bank to mop up liquidity (mainly through reverse repo operations).
Fiscal revenue continues to be buoyant, while expenditure, especially capital spending, has been slow. Revenue grew by 19.4 percent in May (year on year, year to date). Regarding expenditure, as of June 26, with less than one month left until the end of the fiscal year, capital budget execution reached 51 percent of planned spending, while recurrent spending reached 75 percent of budgeted amounts.