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Recent Economic Developments
Nepal’s economy faced headwinds in the first half of FY2020. Following three consecutive years of substantial economic expansion, with growth averaging 7.3 percent per year, Nepal’s economy experienced headwinds in the agriculture, manufacturing, and the service sectors in the first half of FY2020. The agriculture sector was impacted by a delayed monsoon coupled with an outbreak of armyworms, leading to a 1.7 percent (year-on-year) decline in paddy production. In the manufacturing sector, tightening domestic credit conditions, an increased foreign direct investment threshold, and continued low execution rates of public investment projects resulted in a contraction of investment and the number of new businesses registered. Services were impacted by the deceleration in remittances growth and lower tourist arrivals from India, leading to an overall drop in arrivals of 4.3 percent (year-on-year), and an associated slowdown in tourism receipts.
With slower economic activity, imports declined in the first half of FY2020, narrowing the external deficit but adversely affecting revenue collection. The decline in aggregate demand led to a contraction in goods imports by 3.9 percent (year-on-year) in the first half of FY2020. The contraction was broad based, encompassing construction material and machinery, industrial supplies, and food and beverages for household consumption. Services imports also contracted for the first time in four years on the back of lower travel and education service imports. At the same time, a strong goods export performance due to increased palm oil and soybean oil exports to India countered a contraction in services exports, narrowing the current account deficit by 44 percent (year-on-year). The reduction in goods imports, however, contributed to a deceleration in government revenue collection, which is heavily reliant on duties, excise, and value-added taxes (VATs) collected at the border. Between July 2019 and March 2020, revenues grew by 12.2 percent compared to the same period in the previous year, which is the lowest rate since FY2016. Government expenditure expanded by 9.4 percent over the same period due to higher recurrent spending on wages and compensation, goods and services, social assistance, and fiscal transfers.
The global COVID-19 pandemic imposed both a supply and a demand shock on Nepal’s economy, which adversely affected growth. The global crisis induced by the pandemic initially impacted Nepal through the tourism sector, with arrivals from China dropping by around 70 percent in February and a full stop to the issuance of visitor visas taking effect in early March 2020, which has effectively dropped tourist arrivals to zero. The impacts of the pandemic did not remain limited to tourism. On March 21, the Government of Nepal announced a nationwide lockdown, which affected industrial and agricultural production, leading, for instance, to more than a 25 percentage point decline in capacity utilization of industry by early June 2020 and a 64.7 percent (y/y) drop in credit provision to the private sector during the two-month lockdown period. Demand for consumption and production products, such as diesel and petrol, slowed, with many Nepalese experiencing job losses or the inability to outmigrate due to widespread travel restrictions. A domestic outbreak of COVID-19 commenced in May, prolonging the lockdown and imposing substantial human and further economic costs. As a result of the impact of COVID-19, GDP growth in Nepal is estimated at 1.8 percent in FY2020, compared to 7 percent in FY2019. Growth in the service sector is now estimated at 1 percent, the lowest since FY2002, while growth in the industrial sector is estimated at 3.2 percent, a four-year low, due to the deceleration in overall growth.
COVID-19 has increased external and fiscal pressure by reducing foreign currency inflows and revenues. As a result of the pandemic, services exports, goods exports, and remittances contracted by 57.4 percent 62.1 percent, and 43.4 percent, respectively, between March and May 2020 compared to the same period in the previous year. The resulting pressure on foreign reserves was moderated by a substantial decline in goods and services imports, which decreased by 59.6 percent and 59.5 percent, respectively, between March and May 2020, year-on-year. As a result, the current account deficit is estimated to decrease to 7.2 percent of GDP in FY2020 from 7.7 percent in FY2019. While Nepal was able to contain external pressures resulting from COVID-19, the pressure on its finances has been rising. Government revenues contracted by 51 percent between March and May 2020 compared to the same period in the previous year. At the same time, COVID-19 relief measures have increased government spending and are estimated to result in a fiscal deficit of 7.3 percent of GDP in FY2020, compared to 2.6 percent in the previous year. The government aims to finance the deficit through concessional resources from international development partners and domestic borrowing.
The Government of Nepal has responded to the crisis through fiscal and monetary measures. Fiscal measures targeted by the government fall into three broad categories. First, there are immediate health measures aimed at increasing access to testing for COVID-19 infections and the establishment of quarantine facilities, as well as a waiver on customs duties for medical items related to COVID-19 such as masks, sanitizer, and surgical gloves. Second, to reduce the crisis’ impact on livelihoods, the government has implemented food distribution programs, extended eligibility for the Prime Minister’s Employment Program, and provided discounts on utility bills. Third, to provide economic support to firms, the government has deferred the payment of taxes and provided concessional loan facilities to severely affected sectors. The cumulative cost of these programs is estimated at 5 percent of GDP. Measures taken by the Nepal Rastra Bank – the central bank – were aimed at providing liquidity support to banks and facilitating the provision of credit to the private sector. The key measures announced by the central bank included a relaxation of regulatory requirements for banks and financial institutions and a reduction of targeted interest rates as part of the country’s interest rate corridor.
Outlook, Risks, and Challenges
Nepal’s economic outlook remains uncertain. Despite efforts by the government to curb the economic fallout of the crisis, its impact on livelihoods and the economy is expected to be profound. Under a baseline scenario, where global infections and economic stress begin to ease, growth is projected at 2.1 percent (year-on-year) in FY2021. Even though this scenario assumes a gradual economic recovery, growth is expected to remain subdued due to the challenging outlook on tourism and remittances and lower industrial and agricultural production due to lasting supply chain disruptions. The current account deficit is projected to narrow to 6.5 percent of GDP, with imports remaining below precrisis levels due to lower economic activity and low oil prices. While lower imports will continue to limit revenue collection, fiscal measures announced as part of the FY2021 budget, including a revision of customs duties, will provide some support to the budget as spending levels on relief and recovery efforts remain elevated. Taken together, the fiscal deficit is projected to reduce marginally to 6.6 percent of GDP in FY2021.
Risks are tilted to the downside. Given its unprecedented nature, the global economic uncertainty associated with the COVID-19 pandemic is exceptional. Should cases in Nepal continue to rise and should a rebound in economic activity in the country’s major trading partners and remittance-sending countries be delayed, growth in FY2021 risks turning negative, with a contraction of 2.8 percent possible. Due to the large share of the informal economy, an economic contraction would risk exacerbating poverty, inequality, and food insecurity. An associated risk relates to the potential of revenue shortfalls and further fiscal slippage: while the budget for FY2021 has proposed measures to manage an anticipated shortfall in revenue, a prolonged economic downturn risks reducing revenues further while requiring an increase in spending to manage the socioeconomic fallout of the crisis. Such a situation could elevate the deficit to 11.5 percent of GDP.
In addition to the measures already adopted, a strategic and systematic approach is needed to address the above risks. Such an approach that incorporates a medium- to long-term view would include the relevant reforms and measures to support an inclusive and green growth. This edition of the Special Focus outlines the key elements of a strategic approach to transition the economy from the relief stage through to restructuring and a resilient recovery.
Post-Pandemic Nepal – Charting a Resilient Recovery, and Future Growth Directions
The global COVID-19 pandemic has altered economic behavior that will affect growth going forward. With over 10 million infections, 400,000 deaths, and a global GDP contraction of 5.2 percent, the global impact of COVID-19 is unprecedented. The impact of the crisis is not temporary but is likely to induce lasting changes in the way that economies operate. The following four trends are indicative of how economies’ modus operandi will change as they emerge from the crisis:
· Inward Orientation: Increased barriers to the movement of goods and people is likely to alter trade and tourism, and limit outmigration opportunities.
· Increased Vulnerability and Inequality: The economic crisis has resulted in job losses across the board and particularly affected workers in the informal and gig economy who have little or no access to safety nets, accelerating inequality and poverty.
· Digitization: Lockdowns have accelerated a push towards digitization, moving trade in goods and services, social interactions and the provision of public services, online.
· Green Growth: Climate change presents an equal if not larger economic risk than the pandemic, which has led to a global impetus towards an environmentally sustainable economic recovery post COVID-19.
· Debt: Given the large economic shock, leverage of governments, firms and individuals is likely to rise in the aftermath of the crisis, with the potential for systemic risks.
For Nepal to emerge stronger from the crisis, it will be necessary to adapt quickly to this new reality. Nepal is still at an early stage of the crisis, with a domestic outbreak having commenced only in May 2020 and infection rates continuing to rise. The crisis has forced the Government of Nepal (GoN) to make tough choices. The national lockdown that has been in place since March 2020 has been effective in curbing the rapid spread of the virus. However, it has adversely affected the livelihoods of workers in the informal sector. This has generated adverse knock-on-effects, for instance, leading households to neglect health care or education and contributing to a reported increase in gender-based violence. The GoN has initiated select policy measures to buffer the economic impact of the crisis and has started to gradually ease the lockdowns, but a comprehensive roadmap for the response and recovery will be necessary. By drawing on global experiences, this roadmap can allow Nepal to adjust to the new modus operandi induced by the crisis.
An economic framework to chart Nepal’s emergence from the crisis can be structured in three stages: relief, restructuring and a resilient recovery. During the relief stage, the priority is on addressing the immediate health impacts of the pandemic and providing support to livelihoods and firms to reduce vulnerability. As the country brings the pandemic under control and infection rates level-off, the economy can re-open gradually, leading to the restructuring stage. The focus in this stage is on strengthening health systems and adjusting to a new normal that prioritizes domestic employment generation in a greener and more digital economy. The resilient recovery stage focuses on new opportunities to invest and reforms to promote more sustainable, inclusive and resilient growth in a post-COVID world.
Each of the stages has been structured around four pillars. These pillars include measures related to health, social protection, economic measures and cross-cutting priorities:
· Health interventions are critical to save lives and ensure sustainable human capital growth going forward. In the relief stage, the focus of health measures is to contain the spread of the virus and to preserve health services for non-COVID-related infections. Priorities thus involve testing, treating and isolating the infected, which includes the build-up of testing capacity, quarantine centers and specialized health facilities. Information flow among different levels of government will be critical at this stage. In the restructuring stage, efforts can focus on increasing the capacity of the health system, for instance through private sector participation and a strengthening of federalism and restarting crucial vaccination programs. Developing guidelines to manage the gradual easing of the lockdown will also be important. In the resilient recovery stage, building systems for future disease prevention, outbreak response and health surveillance will be critical. This would include developing standard operating procedures to address future pandemics and maintain health service delivery during crises.
· Social support is needed to protect the livelihoods of the poor and vulnerable from current and future shocks and build human capital. In the relief stage, a quick disbursement of cash or in-kind transfers to the most affected and vulnerable households will be critical. An expansion of the Prime Minister’s Employment Program to cover newly unemployed workers and returning migrants will be key to protect livelihoods. Alternative approaches to distance learning could be adopted including radio, TV, and SMS to ensure broader coverage of students. In the restructuring stage, providing employment through public employment programs and supporting entrepreneurship would help along with continued provision of cash or in-kind transfers. The country will also benefit from support to mobile banking and digital financial services, and through the establishment of a digitized social registry. Efforts will also need to be made at getting children back to full-time schooling accompanied with enhanced school sanitation and health protocols. In the resilient recovery stage, the focus needs to be on a strengthened social protection system which can effectively address future shocks, employment support measures through reskilling and revised migration policies, and an education system which is more inclusive and digitally oriented.
· Economic support to firms will be important to generate employment and pivot them towards a greener economy, while managing debt overhang. In the relief stage, liquidity support (time-bound) needs to be provided at the most affected firms with the objective of main employment. The agriculture and tourism sectors could be prioritized, given their criticality for food security and employment. In the restructuring stage, continued support to firms, including through recapitalization, will be needed. Private sector recovery can be supported through targeted investments in digitization and by providing fiscal incentives for green investments. In the resilient recovery stage, efforts need to be aimed at strengthening physical, digital and financial infrastructure to develop e-commerce platforms, enhance access to finance and promote green growth.
· Cross-cutting priorities would need to focus on fiscal sustainability, financial sector stability, a more digitally oriented and green economy and resilient public services. In the relief stage, the focus needs to be on accommodative monetary and expansionary fiscal policy to support banking sector liquidity and provide relief to households and firms. Essential services also need to be maintained together with removing barriers to internet access. In the restructuring phase, expansionary fiscal and monetary policy will likely continue but with increased emphasis on raising revenues and maintaining debt sustainability. It will also be important to assess the impact of the crisis on the financial sector and the health of utility companies so as to plan for a sustainable recovery. Increased emphasis on broadening internet access will support service delivery, with some non-essential services also resuming during this stage. In the resilient recovery stage, it will be important to undertake efforts to rebuild fiscal buffers and strengthen financial sector stability. Pandemic preparedness, financial sustainability of utilities and a strengthened federalism architecture will enable smooth and resilient public service delivery. In addition, enhanced digital systems and connectivity will support service delivery and private sector growth and business continuity. Finally, key elements of green growth would include sustainable and resilient infrastructure, strengthened solid waste management and air and water pollution control.
Last Updated: Jul 31, 2020