Abstract
KEY ISSUES Context: Nepal has been trapped in a low-investment, low-growth equilibrium. The authorities' aim is to graduate from least-developed country status within 7 years. Macroeconomic situation and outlook: The earthquakes in April and May have held back growth. Together with the recent unrest and disruptions to trade routes, they also pushed up inflation. Growth is expected to gradually rebound as economic activity recovers and reconstruction gains momentum. High remittance inflows are supporting a strong external position, as well as high broad money growth. The outlook is subject to considerable downside risk, involving continued political and economic instability and slower-than-expected growth of government capital spending. Medium-term prospects: While remittances are expected to continue to support the external position, the outlook for growth depends importantly on the authorities' reform efforts. Experience in other fragile states shows that natural disasters can have permanent effects on potential growth. This underscores the importance of a decisive boost to public capital spending and reforms to strengthen the business climate. Key policy recommendations: Fiscal policy needs to support post-earthquake reconstruction and medium-term growth through higher public investment. Stronger public financial management (PFM) will be key to the swift and efficient implementation of higher capital spending. Along with efforts to improve the business climate, this should support private investment needed to generate sustained higher economic growth and employment opportunities. The exchange rate peg to the Indian rupee provides a useful nominal anchor to the economy, and the real exchange rate is broadly in line with fundamentals. Money growth should be contained to a level consistent with supporting the peg. The monetary operations framework needs to be strengthened to put the central bank in a position to better control the growth of broad money in the face of strong inflows of remittances and aid. Financial sector reforms should continue to focus on bolstering regulation and supervision, and improving financial infrastructure, to reduce risk and increase access to finance.
1. This statement provides an update regarding the disruption to transportation and trade in the south of Nepal and its implications for economic activity. This information does not alter the thrust of recommendations contained in the staff report but it does alter the staffs assessment of the downside risks to the near-term macroeconomic outlook.
2. The disruption to transportation and trade routes to and from the southern border started two days after the September 20 promulgation of the new constitution All petroleum products consumed in Nepal are imported from India by truck. During the last fiscal year, oil imports represented 15 percent of Nepal’s total goods imports, amounting to US$1.1 billion or 5.3 percent of GDP. The Nepal Oil Corporation (NOC) is the sole supplier of petroleum products in Nepal and the India Oil Corporation (IOC) is the NOC’s sole supplier. With fuel transports into Nepal coming to a virtual halt, the NOC announced in late September that only limited amounts of fuel would be supplied for private vehicles, to slow the drawdown of Nepal’s limited petroleum reserves.
3. The prolonged disruption to trade has resulted in a fuel crisis with an increasingly adverse macroeconomic impact:
In recent weeks, in the absence of viable alternative ways for Nepal to secure adequate fuel in the short term, economic activity has been slowing markedly. The NOC announced on November 9 that it would no longer sell fuel for use in private vehicles and instead prioritize the remaining stock for sales to the security forces.
With winter approaching and shortages of essential supplies worsening, the near-term outlook for Nepal’s population is becoming bleak, particularly for those who became homeless as a result of the earthquakes in April and May. Delays in starting with post-earthquake reconstruction are compounded by the trade disruption. Fuel shortages are affecting the delivery of emergency supplies to remote regions affected by the earthquakes.1 On November 10, in response to acute shortages of cooking gas, petrol, diesel and kerosene, Nepal’s Forest Ministry announced that it would start to provide firewood as an alternative means of fuel.
4. Downside risks to the near-term outlook have become more pronounced. The media in Nepal report that, following a Cabinet decision on November 9, a written request has been sent to the government of India to help end the ongoing problems at the border and ease the supply of essential goods, including cooking gas, petroleum products and medicine to Nepal. To the extent that the trade disruption is not resolved soon and comprehensively, it will be increasingly difficult for overall economic activity to catch up and register positive growth in this fiscal year. Industrial production and tourism are badly affected by the unavailability of fuel and other essential inputs. Government revenue, particularly customs revenue, is down considerably. And so is government spending. The rebound of growth, to 4.4 percent in 2015/16 (mid-July 2015-mid-July 2016), projected in the staff report is predicated on a marked increase in government capital spending as well as reconstruction activity by the private sector. Over the past three years, government capital spending through mid-November averaged only about 6 percent of the total for the fiscal year. As noted in the staff report, during the Article IV consultation mission the authorities were confident that capital budget implementation would again pick up after the end of the festival season in mid-November.
In the context of a November 10 press briefing by a United Nations spokesperson, the Secretary-General reiterated his concern over the obstruction of essential supplies on the Nepal-India border. Acute shortages in fuel supplies continue to impede planned deliveries to earthquake-affected villages in Nepal. Humanitarian organizations urgently require fuel to maintain operations and deliver food, warm clothing and shelter materials to high altitude areas that will soon be cut off by harsh winter weather. The Secretary-General underlined Nepal’s right of free transit, as a landlocked nation as well as for humanitarian reasons, and called on all sides to lift the obstructions without further delay.