The latest Nepal Development Update, out on September 2017, focuses on increasing domestic and external risks in the economy despite a strong rebound in fiscal year 2017. In the Special Focus of the Update, we take a closer look at the main emerging issues and potential risks in the design of fiscal architecture for the new federal Nepal. Read the synopsis in our news release.
Economic activity in Nepal, which rebounded strongly in FY2017, reaching 7.5 percent (year over year [y/y]) following two challenging years, has again been impacted by severe flood affecting more than one-third of the country.
Global growth is picking up and the growth in the South Asia region continues to remain strong. A recovery in industrial activity has coincided with a pickup in global trade, after two years of marked weakness. Growth in South Asia remains strong, with regional output projected to grow by 6.8 per-cent in 2017 and an average of 7.2 percent in 2018–19.
Economic activity in Nepal, which rebounded strongly in FY2017, reaching 7.5 percent following two challenging years, has again been impacted by severe flood affecting more than one-third of the country.
High inflation in the last two years induced by disruptions moderated sharply by early 2017 and further slowed, reaching decade-low inflation by the end of FY2017, due to moderating inflation in India.
Credit growth soared during the first half of the fiscal year and, coupled with a simultaneous slow deposit mobilization, which had led to a squeeze on the availability of loanable funds at banks, had eased off by the end of the fiscal year. However, interest rates have not come down despite the availability of loanable funds because the banks had committed to offer higher interest rates to attract new deposits during credit crunch.
As imports continue to surge and exports to falter, the trade deficit has further increased. Remittances, which financed almost all imports in previous years, has continued to slow. Consequently, the current account has narrowed significantly from 6.2 percent of GDP in FY2016 to a deficit of -0.4 percent of GDP in FY2017.
Annual revenue growth has been robust, with government exceeding the revenue target. Public spending has also significantly picked up in real terms, with capital spending reaching a record high at almost 8 percent of GDP in FY2017. Fiscal deficit reached 3.3 percent of GDP in FY2017.
Outlook, Risks and Challenges
Economic activity, which was expected to progress well in FY2018, has been set back by another natural disaster. Severe floods in mid-August, the third major shock in three consecutive years, has caused severe disruptions and damages especially in the southern plains. Over 1.7 million people have been affected by flood and landslides. Houses, bridges, roads, and other infrastructure have also been damaged.
While the estimates of damages remain preliminary, the growth for FY2018 is expected be lower than earlier forecasted and moderate thereafter, in line with the potential averaging 4.5 percent in the forecast period.
With increased government spending due to a transition to new federal structure and earthquake and flood-related spending, the fiscal deficit is expected to widen in FY2018 to 4.3 percent of GDP. Financing is not expected be a problem given ample fiscal space with a low debt-to-GDP ratio and a large cash balance at hand.
Meanwhile, the current account, which turned into a marginal deficit in FY2017, is expected to widen as import growth is expected to remain high, while remittances and exports growth are expected to grow slowly.
Both domestic and external risks predominate and are on the downside. The political environment remains fluid as the term of the new government—which was sworn in in July 2017 as part of the power-sharing agreement among the coalition partners—will come to an end in late 2017, after the provincial and federal elections.
Transition to a new federal structure and smooth service delivery are also going to be new risks and challenges. With local elections expected to be completed by September 2017 and provincial and federal elections by December 2017, FY2018 will be a transitional year in implementation of the new federal constitution.
Despite improvements, the overall pace of earth-quake reconstruction remains modest, which is now compounded by flood recovery as the government needs to manage response to two separate natural disasters.
The external environment is likely to pose a risk, as well. The decline in migrant workers’ outflow has been compounded by Qatar’s political woes—a major destination of Nepali migrants—which may cause a sharper deterioration of balance of payments.
In this edition of the Update, we take a closer look at the main emerging issues and potential risks in the design of fiscal architecture for the new federal Nepal.
In general, issues regarding the transition to federalism can be grouped into three categories: functions category (i.e. which level is responsible for delivering which service), finance category (i.e. which level or levels collect revenue and raise debt), and functionaries category (i.e. how will existing civil service be transformed). All the issues under these three categories need to be resolved effectively for government service delivery not to get disrupted.
In sum, while the constitutional provisions and set of laws currently under consideration in the Parliament, will create a mismatch between the levels that collect revenue and those that are responsible to service delivery, this does not have to be problematic if the system of intragovernmental transfers is designed properly.
Download the latest report here.
Last Updated: Sep 15, 2017