Nepal: Staff Report for the 2017 Article IV Consultation—Informational Annex
Author: International Monetary Fund. Asia and Pacific Dept
Publication Date:
27 Mar 2017
eISBN:
9781475589009
Language:
English
Keywords:
ISCR; CR; exchange rate; real GDP; financing; growth; GDP deflator; IFC team; health sector Mgmt reform PforR; NRB policy rate; core inflation; prime lending rate; External sector statistics; Balance of payments statistics; South Asia; financing instrument
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Nepal's economy is rebounding following a slowdown caused by the 2015 earthquakes and trade disruptions at the southern border. The upswing has been supported by the new government's efforts to revitalize the reform agenda. The key challenge is to put policies in place that will extend the cyclical recovery into a sustained period of high and inclusive growth.

Abstract

Nepal's economy is rebounding following a slowdown caused by the 2015 earthquakes and trade disruptions at the southern border. The upswing has been supported by the new government's efforts to revitalize the reform agenda. The key challenge is to put policies in place that will extend the cyclical recovery into a sustained period of high and inclusive growth.

Fund Relations

(As of January 31, 2017)

Membership Status: Joined September 6, 1961; accepted Article VIII, Sections 2, 3, and 4 on May 30, 1994.

General Resources Account:

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SDR Department:

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Outstanding Purchases and Loans:

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Financial Arrangements: (In SDR Million)

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Projected Obligations to Fund:

(in millions of SDRs; based on existing use of resources and present holdings of SDRs):

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Exchange Rate Arrangement

Nepal unified its exchange rate in February 1993. Since October 1997, the exchange arrangement of Nepal has been reclassified as pegged to a single currency unit. The Nepalese rupee is pegged to the Indian rupee at a rate of 1.6. Currently, all merchandise imports (except for a few goods restricted for security or related reasons) are freely available through an open general license system, with foreign exchange provided through the banking system at the market exchange rate.

As of February 14, 2017, the exchange rate of the Nepalese rupee (Nr) was US$1=Nrs. 107.13. The restriction on quantitative limits on foreign exchange for leisure travel was removed in early 2011. The Industrial Enterprises Act places a 75 percent limit on the conversion and transfer to foreign currency of salaries of non-residents from countries where convertible currency is in circulation. Since the limit applies to amounts that may be less than net salaries, it gives rise to an exchange restriction under Article VIII.

Safeguards Assessments

An update safeguards assessment of the Nepal Rastra Bank (NRB) was completed in February 2016 with respect to the Rapid Credit Facility approved on July 31, 2015. The assessment found that the NRB had made limited progress in improving its safeguards framework and addressing recommendations from the previous assessment (2011). In particular, the quality of the external audit continued to fall short of international standards and priority should be given to engaging an auditor with requisite experience. The legal framework should also be enhanced to strengthen the central bank’s autonomy and governance arrangements. The assessment concluded that strong commitment from the NRB Board and management is essential to improve the internal audit function and reinforce controls in key areas, including foreign reserves management and currency operations.

2015 Article IV Consultation

The Executive Board discussed the staff report for the 2015 Article IV consultation (IMF Country Report No. 15/ 317) on November 16, 2015. Consultations with Nepal are held on the standard 12-month Article IV consultation cycle.

Technical Assistance (since 2012)

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Resident Representative

Mr. Andreas Bauer has been the Senior Resident Representative since June 15, 2016. He is based in New Delhi.

Relations with the World Bank Group

(As of February 2017)

A. Partnership in Nepal’s Development Strategy

Nepal has achieved remarkable development progress since 2006. Poverty has declined with poverty headcount ratio at US$1.90 per day (2011 PPP) decreasing from 46.1 percent in 2003 to 15 percent in 2010.1 Several social indicators in education, health and gender have improved. Economic growth averaged at 4.5 percent (2006-2015), one percentage point higher than level achieved during the conflict period. Yet, Nepal is constrained in taking advantage of its economic potential and the country is vulnerable on the political and economic fronts and to exogenous shocks, in particular natural disasters such as the devastating earthquakes in 2015 and the trade disruptions from late 2015 to early 2016.

The country is recovering from the earthquakes and the trade disruptions, which had a huge impact on Nepal’s economy and its people. A large portion of the 45 percent of total population that are considered vulnerable2 may have fallen back into poverty in the aftermaths of the two exogenous shocks. The next round of National Living Standard Survey expected in 2017/2018 will provide data to substantiate the poverty trends.

Under the Fourteenth Periodic Plan (2017-2019), Nepal aims to achieve higher equitable and sustainable growth. To move to a higher growth trajectory, Nepal will need to boost its efforts to remove bottlenecks to long term growth and development. The World Bank Group supports these efforts through its Country Partnership Strategy (FY14-18). The Country Partnership Strategy discussed by the World Bank Group Board of Executive Directors in 2014 constitutes a major shift in support away from short-term post-conflict assistance to establishing the foundations for increased and inclusive growth after three consecutive interim strategies in Fiscal Years (FY) 2007, 2009 and 2011. The World Bank Group continues to be responsive to the evolving country situation and emerging development challenges. Nepal is expected to receive an increase in allocation of IDA resources under IDA18 (FY18-20), including from its Exceptional Risk Mitigation Regime aimed at strengthening the country’s resilience.

B. IMF-World Bank Collaboration in Specific Areas

Areas of World Bank leadership

The World Bank has been leading the policy dialogue and engagement in infrastructure, social sectors, agriculture and rural development, which are constraining factors to sustained and inclusive growth in Nepal. In addition, the World Bank has been leading the coordination efforts for disaster management, and has been supporting efforts towards sustainable environment management.

The World Bank Group has been expanding its support in the energy sector, particularly in hydropower development. Progress in this sector has been uneven due to governance and government capacity issues. The World Bank (International Development Association), International Financial Corporation (IFC), and Multilateral Investment Guarantee Agency (MIGA) are jointly carrying out a Joint Implementation Plan in hydropower development with the goal of supporting transformational hydropower projects. The World Bank and IFC teams have jointly been supporting the development of the Kabeli-A hydropower project and Upper Trishuli 1 hydropower project for which MIGA is considering extending a guarantee. In addition, the World Bank is preparing the Energy Sector Development Policy Credit to support policy, legislation and institutional reforms in the power sector to promote sustainable development, improved investment climate for private participation and improved services, governance and financial performance.

In the transport sector, the World Bank is providing investment project financing for a number of operations to improve all season road access and connectivity. It is also supporting the government program to provide safe, reliable and cost effective bridges as part of Nepal’s Strategic Roads Network. This initiative utilizes the program-for-results (PforR) financing instrument that links disbursements of funds directly to the achievement of verifiable results.

In the social sectors, the World Bank has been actively supporting the government across the education sector including school sector3, higher education, and technical and vocational education and training. Key reforms include to strengthening the quality, efficiency, market relevance and equity; and improving the governance and management of the education system. Recent initiatives include the School Sector Development Program (FY17 approval) using the PforR financing instrument and supporting the government’s School Sector Development plan. It builds on the School Sector Reform Program, which used a Sector Wide Approach (SWAp) involving the government and 13 development partners, of which 10 partners pool their resources with those of government4. The World Bank has also been supporting reforms to improve quality, relevance, and efficiency of higher education and of vocational training.

In the health sector, the World Bank has been working closely with the government and development partners to support the government’s sector program since 2004 through a SWAp, similar to its engagement in the education sector. Building on this support, the World Bank has recently approved the Health Sector Management Program, a PforR operation that addresses the governance and efficient management of public resources.

To support an increase in agriculture productivity and rural development, the World Bank is financing operations to improve agricultural productivity and irrigation and water resource management. It is supporting efforts to promote social inclusion, including through the Poverty Alleviation Fund (PAF) that channels resources to the poorest groups in rural communities for small infrastructure development, employment and income-generating opportunities.

Following the devastating earthquakes in 2015, the World Bank responded with the $200 million housing reconstruction project; the Post-Disaster Needs Assessment identified housing reconstruction as the largest single need after the earthquakes.

World Bank Contributions to the IMF Work Program

The World Bank is collaborating and complementing the IMF work program in a few key areas. The World Bank and IMF have been working closely to provide support to strengthen the financial sector, such as implementing the joint Financial Sector Assessment Program. There has also been close collaboration in developing a series of Development Policy Credits (DPCs) financed by the World Bank that aims to address economic risks by reducing vulnerabilities of the banking sector. The World Bank has also been providing technical assistance in the areas of crisis management, bank resolution and deposit insurance.

The World Bank and IMF continue to provide policy advice and technical assistance in macroeconomic management. This includes support in debt management through technical assistance, joint Debt Sustainability Analysis and policy dialogue to ensure fiscal and debt sustainability.

In the area of public expenditure, the World Bank has carried out public expenditure analysis, and provided technical assistance, such as for Medium Term Expenditure Framework. Under the ownership and leadership of the government, the World Bank supported the Public Expenditure and Financial Accountability Assessment (second assessment) in 2015. This ushered in joint government and donor collaboration for public financial management reform action plan, which is expected to ensure effective use of resources for priority projects.

C. World Bank Group Strategy and Lending Operations

Under the World Bank Group (WBG) Nepal Country Partnership Strategy (FY14-18), the WBG is focusing on two pillars: (a) increasing economic growth and competitiveness by expanding hydroelectric power generation, enhancing transport connectivity, and improving the financial sector and the investment climate and (b) promoting inclusive growth and opportunities for shared prosperity through enhancing agriculture sector productivity and improving access to and quality of education, healthcare, skills development, and social protection. As a cross-cutting priority, the WBG engages in strengthening institutional governance and capacities, mainstreaming gender and citizen engagement, and helping Nepal to address vulnerabilities to climate change impacts and mitigate the effects of natural disasters. WBG support is guided by the principles of balancing risks and rewards, selectivity and flexibility.

Given the evolving country context, and the emerging development challenges, there are a number of areas where the WBG is considering scaling up its engagement in the near term including:

  • supporting the government in its transition to a federal state,

  • helping create jobs domestically given the potential further decline in overseas employment opportunities and youth bulge,

  • providing assistance to strengthen resilience against natural disasters including earthquakes, and

  • intensifying engagement on policy reforms to improve institutional governance.

Under IDA17 (FY15-17), Nepal is expected to receive approximately US$1.2 billion (US$901 million from core IDA and US$300 million from Crisis Response Window for emergency needs following the 2015 earthquakes). Financing has been on a credit-only basis as Nepal’s risk of debt distress was assessed to be low. As of mid-February 2017, the portfolio consisted of 18 IDA projects with a combined net commitment of US$1.72 billion. In the aftermath of the earthquakes and trade disruptions, only one energy technical assistance project was approved, but four operations were granted closing date extensions in FY16. Under IDA18 (FY18-20), Nepal is expected to receive a substantial increase in IDA resources. The WBG is expected to finance projects in high priority areas such as the Upper Trishuli 1 hydropower project, the Fiscal DPC, the Financial Sector DPC4, the Energy Sector DPC, and the Fast Track Highway, an ambitious initiative to improve internal transport connectivity. The increase in resources will also finance efforts to address the emerging development challenges noted above.

The World Bank Group is starting to prepare the Systematic Country Diagnostic in the second-half of FY17 and is expected to prepare a new Country Partnership Framework in FY18.

Activities of the International Finance Corporation (IFC) in Nepal

IFC has been working on private sector opportunities and constraints through investments and advisory services to address the key development gaps in Nepal. IFC is focusing on sustainable infrastructure, inclusion, and competitiveness/jobs. In infrastructure, IFC is currently supporting breakthrough hydro power projects that have the potential to turn Nepal into a power surplus country and attract significant FDI. To enhance inclusion, IFC is working on increasing access to financial services for individuals and MSMEs. In the competitiveness/jobs space, IFC is focusing on agribusiness, tourism, manufacturing and services.

IFC’s cumulative committed portfolio stood at $52 million as of the end of FY2016 and its advisory services portfolio totaled to $13.3 million. Infrastructure accounted for 68 percent of the total investment portfolio while Telecom, Media, Technology, Venture Capital and Funds accounted for 13 percent. Financial Institutions Group (FIG) and Manufacturing, Agribusiness, and Services (MAS) each had a 9 percent share of the portfolio. Advisory services are in the areas of financial sector, hydro energy, agribusiness, SMEs, tourism, airport PPP, and investment climate.

In the energy sector, IFC has been helping unlock barriers for new infrastructure projects, particularly in hydropower. IFC is working closely with IDA on the joint Kabeli-A Hydroelectric Development Project. In addition, IFC is achieving significant progress on its work on the ground-breaking 216MW Upper Trishuli 1 hydropower project. In the financial sector, IFC is supporting banks and venture funds that finance SMEs and providing trade finance products. Through advisory engagements, IFC is helping enhance financial infrastructure, support financial product development, improve risk management in financial institutions, and strengthen payment regulations. In agribusiness, IFC, through a lead firm, is supporting farmers with climate smart agricultural practices, and in tourism, IFC is helping the government of Nepal in developing new tourism destinations. To support an environment for increased private sector engagement, IFC through the joint Global Practice on Trade and Competitiveness, has been working with the government on broad investment climate and sector specific regulatory reforms.

IFC will continue to work closely with the World Bank to help address institutional capacity constraints to accelerate progress in existing private sector projects and attract more private sector engagements

Table 1.

Nepal Portfolio

(as of February 15, 2017)

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Relations with the Asian Development Bank

Country Program

The Asian Development Bank (ADB) began lending to Nepal in 1969. As of 31 December 2016, Nepal has received 178 loans/grants—136 sovereign ADF loans ($4,028.2 million), 5 non-sovereign loans ($52.8 million), and 34 ADF grants ($823.8 million), 1 OCR loan ($2.0 million), and 2 ADF special grants ($3.3 million) totaling $4,910.0 million. Nepal Country Partnership Strategy (CPS) 2013–2017, approved in October 2013, allocates most of the CPS resource envelope to operations in energy, transport, and urban infrastructure and services, followed by agriculture and education. Five thematic priorities—gender equality and social inclusion, environmental sustainability, good governance, regional integration, and private sector development will be mainstreamed in ADB operations. The portfolio of active sovereign ADF loans and grants as of 31 December 2014 consists of 34 ADF projects and programs (25 loans amounting to $1,654.7million and 21 grants amounting to $328.3million) with an overall net amount of $1,983.0million.

The assistance approved in 2016 comprised two projects with a total of $306.8 million in ADF loans. The projects include the Supporting School Sector Development Plan (results-based lending, $120 million); and SASEC Roads Improvement Project ($186.8 million). In addition, a $20 million co-financing grant from Strategic Climate Fund was also approved as an additional financing to South Asia Subregional Economic Cooperation Power System Expansion Project to promote solar power.

Technical Assistance

As of 31 December 2016, ADB has approved technical assistance (TA) projects totaling $193.7 million, there were 22 ongoing TAs amounting to $34.9 million. Currently, 23 investment projects and 6 TAs, which are about 68% and 27%, respectively, of the ADB’s Nepal portfolio, are being administered by Nepal Resident Mission.

Private Sector Operations

ADB’s private sector operations in Nepal began in 1989. As of 31 July 2016, cumulative approvals in four projects amounted to $58.6 million. The most successful of these was the 60-MW Khimti Hydropower (approved in 1996), which paved the way for private sector investment in the hydropower sector. The project was built under a 50-year build-own-operate-and-transfer license to Himal Power Limited. ADB’s loan has been fully repaid.

ADB’s Trade Finance Program (TFP) in Nepal works with two banks and has supported over $71 million in trade with 209 transactions as of 30 June 2016. About 51% of the trade supported by the TFP was cofinanced by the private sector. It fills market gaps by providing guarantees and loans through partner banks in support of trade.

Looking ahead, ADB’s private sector operations will focus mainly on hydropower development, both for domestic sale and for export to India although many constraints to investment remain and further policy dialogue is required.

Table 2.

Sovereign Loans and Grants by the Asian Development Bank, 1968–2016

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Statistical Issues

As of February 14, 2017

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Nepal—Table of Common Indicators Required for Surveillance

(As of February 10, 2017)

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Any reserve assets that are pledged or otherwise encumbered should be specified separately. Also, data should comprise short-term liabilities linked to a foreign currency but settled by other means as well as the notional values of financial derivatives to pay and to receive foreign currency, including those linked to a foreign currency but settled by other means.

Both market-based and officially-determined, including discount rates, money market rates, rates on treasury bills, notes and bonds.

Foreign, domestic bank, and domestic nonbank financing.

The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments.

Including currency and maturity composition.

Includes external gross financial asset and liability positions vis-à-vis nonresidents.

Daily (D); weekly (W); monthly (M); quarterly (Q); annually (A); irregular (I); and not available (NA).

1

According to Nepal’s national poverty line, 25.2 percent of the population live in poverty. The national poverty line established in 2010/2011 represents the expenditure required to meet the minimum food and non-food needs, and has historically been measured using the Nepal Living Standards Survey. It is the primary benchmark for poverty monitoring as well as identifying and targeting the poor tin Nepal.

2

Households with more than 10 percent probability of falling back into poverty are considered “vulnerable” households in Moving up the Ladder, World Bank 2016.

3

Also includes early childhood education and non-formal education.

4

Three development partners supported the program directly through parallel financing and two pooling partners provided both pooled and non-pooled support.

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Cover IMF Staff Country Reports
Nepal: 2017 Article IV Consultation-Press Release; Staff Report
Author: International Monetary Fund. Asia and Pacific Dept
Volume/Issue:
Volume 2017: Issue 074
Publisher:
International Monetary Fund
ISBN:
9781475589009
ISSN:
1934-7685
Pages:
73
DOI:
https://doi.org/10.5089/9781475589009.002