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Nepal Development Update


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World Bank

The Nepal Development Update is produced twice yearly with two main aims: to report on key economic developments over the preceding months, placing them in a longer term and global perspective; and to examine (in the Special Focus section) topics of particular policy significance. The Update is intended for a wide audience including policymakers, business leaders, the community of analysts and professionals engaged in economic debates, and the general public.

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Recent Economic Developments           

Economic growth in Nepal remained robust for the third year in a row, reaching 7.1 percent in FY2019. This is in contrast with past growth that averaged 4.1 percent a year between FY2007 and FY2016.  The service sector accounted for 57 percent of the growth, and the agriculture sector contributed an additional 24 percent.  Higher remittance inflows and a surge in tourist arrivals translated into higher growth in retail trade, real estate, transport, and hotel and restaurant services. Good monsoons and increased commercialization coupled with improved availability of fertilizers, seeds, and irrigation facilities contributed to higher paddy, maize, and wheat production. Higher remittances also supported increased private consumption, while private investment expanded because of regular electricity supply and greater political and policy stability. However, public investment contracted as post-earthquake housing reconstruction slowed and national pride projects like Melamchi water supply and Upper Tamakoshi hydroelectric were further delayed. Net exports continued to underperform.

A good agricultural harvest helped keep inflation subdued at 4.6 percent in FY2019. Food price inflation remained low at 3.1 percent, while non-food price inflation rose to 5.9 percent, driven by housing and utility prices.  Inflation was also contained by the Nepalese rupee peg to the Indian rupee (at the rate of 1.6 to 1).  Prices movements in Nepal follow those in India with a lag.  However, in the last two months of FY2019, inflation spiked to above 6 percent (y/y), triggered mainly by government testing of vegetables and fruits imported from India for pesticides.  This reduced food imports and domestic supply.  Private sector credit drove growth in the money supply of 15.8 percent (y/y).  Nepal Rastra Bank (NRB) adopted measures to limit overdraft facilities and hire purchases, which slowed private credit growth to 19.3 percent. Growth in deposits also slowed to 17.7 percent, mainly from a reduction of the ceiling on the share of institutional deposits (out of total deposits) held by banks. The continued higher level of credit relative to deposits growth limited the availability of loanable funds and kept interest rates elevated.

The financial sector remains stable, but a rising trend in non-performing loans point to some emerging vulnerabilities. Non-performing loans (NPLs) remain low but increased by 25 percent in 7 of the 25 private commercial banks, as elevated lending rates pushed some borrowers into default. All banks and financial institutions (BFIs) are well capitalized and meet the capital adequacy ratio requirement of 11 percent. However, capital adequacy ratios have declined over the past year, with development banks recording the largest decline. The NRB has been encouraging mergers and acquisitions to further strengthen the financial system and curb unhealthy competition.

With a lower growth in imports, the current account deficit narrowed marginally in FY2019 but remains large. Import growth decelerated to 5.2 percent (y/y). Slower growth was evident across all categories of imports, except consumer goods.  Imports of capital goods and industrial supplies declined, as one-off capital imports to support federalism and housing reconstruction tapered off. Quantitative restrictions on sugar imports (to protect domestic producers) coupled with restrictions on vegetables and fruit imports from India reduced imports of food and beverages.  In contrast, exports grew by 10.7 percent (y/y) on the back of increased demand for non-crude palm and soybean oil from India. This was helped by tariff exemptions on Nepalese exports to India (under the South Asian Free Trade Area Agreement), while other countries face tariffs of 54 percent on palm oil and 45 percent on soybean oil. Despite the lower import growth, the trade deficit far exceeded remittance inflows because of the high dependence on imports. As a result, the current account deficit (7.7 percent of GDP in FY2019) remained high. Foreign exchange reserves were used to partly finance the external deficit, leading to a decline in international reserves of the central bank for the first time since FY2010 to US$8 billion (6.8 months of imports) from a peak of US$9.5 billion in July 2018.

Robust revenue growth coupled with persistent underspending of the budget reduced the fiscal deficit from 6.7 percent of GDP in FY2018 to 1.9 percent in FY2019. Revenues grew by 17.7 percent (y/y), driven by income tax, value-added tax (VAT), and excise tax collections, all of which grew by more than 15 percent. Trade-related taxes were, however, lower than budgeted because of lower import growth. The robust performance of revenues was supported by: (a) a 20 percent surcharge on individual earnings of more than NPR 2 million; (b) higher excise duties on alcohol and tobacco and luxury vehicles; (c) a wider tax base for the VAT (for liquor, cigarettes, sanitary products, electronics, and construction materials in metropolitan and sub-metropolitan areas); and (d) introduction of a health risk tax on the production and import of cigarettes.  On the expenditure side, total government spending dropped 2.7 percent (y/y). Capital spending declined for the first time since FY2006 as earthquake reconstruction efforts plateaued, national pride projects got further delayed and subnational governments were unable to spend. Recurrent expenditures grew marginally, by 0.9 percent, the lowest increase in the past 15 years, despite higher fiscal transfers to local and provincial governments. Underspending of the budget persists mainly from limited technical capacity of existing staff and delays in the hiring of new staff at the subnational levels. To address some of the challenges linked to public expenditures, the government has started implementing certain recommendations put forth by the public expenditure review commission.  The lower fiscal deficit and large government balances have constrained public debt to around 30 percent of GDP.

Fiscal federalism reforms are progressing with the increased transfer of resources to subnational governments and ongoing reforms to strengthen the fiscal transfer system. Fiscal transfers to local governments increased to 9 percent of GDP in FY2019.  An additional 3 percent of GDP was also transferred with the initiation of revenue sharing. Work is underway to refine and further align the fiscal transfer framework with the Constitutional provisions that stipulate a fiscal gap approach. This work also entails further clarification of functions and service delivery norms that will define subnational expenditure needs. The basic elements of a functioning intergovernmental finance system are in place for budgeting and financial reporting. Over the medium-term, the system will need to be upscaled to support program monitoring for results and to inform subnational decision making. So far, the federalism successes have been possible because of implementation of key legislation such as the recent enactment of the Fiscal Procedures and Financial Responsibility Bill that governs public financial management across all tiers of government. Progress has also been possible due to the high-level political commitment.

 

Outlook

GDP growth is projected to average 6.5 percent over the medium term. A steady inflow of remittances coupled with high tourist arrivals is expected to drive growth in services. Among the key measures and investments that will help buoy tourist arrivals are (a) the Visit Nepal 2020 program; (b) completion of the second international airport; (c) construction of several big hotels; and (d) the increase in air connectivity through the implementation of new/revised air service agreements with different countries including Australia, Cambodia, China, the United Arab Emirates, and Vietnam. However, the recent delays in the monsoons coupled with climate-related natural disasters, the outbreak of armyworms that damaged crops, and fake paddy seeds used for growing crops are expected to reduce growth in agricultural production. Construction activities, new investments in the cement and hydropower sectors, and improved capacity utilization in the manufacturing sector will support industrial growth. Efforts to build subnational capacity and the implementation of performance-based contracts are also likely to improve government spending.

Private investment, in contrast, will be supported by the implementation of the 2019 national work plan to minimize the trade deficit; the establishment of the Nepal Infrastructure Bank, which will help finance large and critical infrastructure projects; and the operationalization of a one-stop service center for investors. More recently, the government has set up the Investment Reform Delivery Unit under the Prime Minister’s office to advance doing business reforms.

The trade deficit is expected to trend downward over the medium term. This is because import growth will likely slow further as the spending on federalism-related infrastructure and post-earthquake reconstruction decline while the government implements a work plan for encouraging import-substituting industries. Electricity exports are expected to improve in the next few years, but broader export growth will depend on structural reforms (to boost competitiveness) yielding results. Remittances as a share of GDP are projected to stabilize at around 25 percent over the medium term. The external gap will be financed primarily by long-term borrowing and some drawdown in reserves. International reserves are projected to cover close to five months of imports by FY2021. There are negligible portfolio investments in the country and foreign direct investment is likely to remain low over the medium term.

The fiscal deficit is projected to average around 3 percent of GDP, with a likely pickup in spending. Revenue performance is projected to remain robust as the government proceeds with reforms to improve tax mobilization. These include (a) improvements in tax administration through the operationalization of systems for vehicle and consignment tracking, biometric registration, and electronic tax payments; (b) strengthening VAT collection by providing an incentive for partial VAT refunds when payments are made electronically or through bank cards, (c) simplification of the tax structure by adopting a Single Tax Code to support greater compliance; and (d) the creation of a private-investment-friendly environment for productive industries and businesses. Efforts are also underway to strengthen own-source revenue of subnational governments.  As provincial and local governments become fully functional, spending is likely to increase, and the fiscal deficit is projected to reach 3.3 percent of GDP by FY2021. The implementation of the Public Expenditure Review Commission recommendations is expected to support greater spending efficiencies. In addition, Development Partners, including the World Bank, are working to improve various facets of Public Financial Management and Public Investment Management. The fiscal deficit will be financed by a mix of domestic and international borrowing, and the availability of concessional financing is likely to continue.

 

Risks and Challenges

Persistently high trade deficits raise risks to the external sector. This could potentially be exacerbated if geopolitical tensions escalate in migrant receiving countries, thereby impacting remittance inflows. Lower remittances could also adversely impact the liquidity of the financial system. This risk is mitigated, in part, by measures to support exports and reduce imports.

Climate-related natural disasters resulting from erratic monsoons could adversely impact agricultural production and existing infrastructure and reverse the gains in poverty reduction. Recent delays in the monsoons and the outbreak of armyworms that damaged crops in parts of the country are likely to lower agricultural growth in FY2020. The government has been implementing reforms to strengthen the institutional framework for improved management of climate-related disasters, which will help mitigate some of these risks. Also, new construction is slated to be more resilient to climatic shocks, while there is increased emphasis on renewables through investments in hydropower projects.

In addition, capacity and staffing challenges persist, particularly at the subnational levels, and this could continue to affect budget execution and service delivery. Measures will be needed to strengthen planning and budgeting at the subnational levels, including implementation of subnational Medium-Term Expenditure Frameworks.  Moreover, it will be important to adopt a legal framework for hiring staff at the subnational level, and a capacity building program for all staff.

Underpinning the above challenges is the need for more and better data that will support evidence-based reforms and risk mitigation efforts. This is the focus of the special topic section of this Nepal Development Update on data, which outlines the key data gaps as well as the legal and institutional framework for data and statistics in federal Nepal. It highlights the important role of data in supporting development and fostering transparency and accountability. The section aims to assist the government in envisioning a future data ecosystem that harnesses new technologies and new data sources to meet the growing demand for knowledge and evidence to steer Nepal’s development progress.

 

Special Focus – Envisioning a Future Data Ecosystem in Federal Nepal

Nepal’s historic transition to federalism has created a surge in demand for more and better data. One of the primary purposes of decentralization is to improve public service delivery. Data and evidence-based analysis beyond heuristics and anecdotes play critical roles in achieving and measuring results. Aspirations are apparent, as declared by the Rt. Hon’ble President of Nepal during her address to the joint session of both Houses of the Federal Parliament in 2018, that the country’s “development in the days to come will be based on intensive analysis of information and data, research and evidence.” About 60 percent of the newly elected local leaders are new to politics,[1] and a renewed sense of accountability is emerging as they strive to deliver the promises to their constituencies.

Data can play a critical role for successful implementation of federalism and accelerating development progress. Governments’ core activities – including policy development, program implementation, and performance monitoring – all require data. The need for data is amplified as federalism brings the decision-making power to provinces and local governments. As the United Nations put it, “Data are the lifeblood of decision-making,”[2] and it is difficult to successfully implement federalism without high-quality data.

Globally, the internet and other digital technologies have led to an unprecedented increase in data production during the last two decades. At the turn of the 21st century, there were approximately 5 billion gigabytes of information available. By 2012, the same volume of information was created every two days. By 2016, 90 percent of data in existence were produced in the preceding year.  The preceding 12 months produced nine times as much data as the world has produced previously.

The global data revolution is propelled by three mutually reinforcing factors. These include the ability to collect and store data digitally, the ability to share data instantaneously through the Internet, and the ability to analyze large volumes of data owing to the vast improvements in computer processing power.

Nepal’s data ecosystem needs to build around three analogous dimensions that spurred the global data revolution: data production, data sharing, and data use, all of which must be built on a strong data governance structure. So far, the focus in Nepal has been on data production. Without improving data sharing and data use, however, additional data production will not contribute much to the growth and dynamism of the ecosystem, represented by the volume of the cube in Figure 1. The value of new data can be maximized only if the data can be widely shared and used by many.

Data evolve in an ecosystem, an environment in which a wide range of actors produce, use, and exchange data and data analytics across sectors and national boundaries. In many ways, this concept supersedes a national statistical system, traditionally spearheaded by a National Statistics Office that serves as the custodian of official statistics and is the main data producer for the government. It consists of more than government actors, such as the private sector, civil society, media, academia, and development partners.

Nepal’s data ecosystem is facing a fundamental and inevitable paradigm shift. National Statistics Offices around the world are facing the need to graduate from data producers, relying on traditional surveys and censuses, to data integrators that exercise leadership and coordinate key actors to foster an effective and sustainable data ecosystem. Inaction will leave Nepal behind in the global data revolution and jeopardize the government’s lofty goals for building a prosperous Nepal. Timely and visionary leadership, however, will enable Nepal to unlock the value of the data ecosystem to propel the economy and society forward.

The Central Bureau of Statistics (CBS) is at the core of Nepal’s data ecosystem. Established under the Statistical Act 1958, the CBS has long been regarded as the sole custodian of official statistics for the Government of Nepal. For example, the recently completed National Economic Census 2018 is a historical landmark, as it is the first such census in Nepal. The CBS is preparing for the next round of the Population and Housing Census in 2021. This census is a golden opportunity to bring a fresh set of benchmark data for all three tiers of government.

More than 60 years after the original Statistics Act, the CBS is no longer the sole government authority collecting data. Many line ministries and specialized agencies maintain administrative databases generated from the operation of public agencies such as registration, transaction, recordkeeping, and service delivery. All provincial governments and local governments will join the ranks of data producers and users in Nepal’s data ecosystem. The unbundling report of the Constitution lists almost 50 responsibilities directly or indirectly related with data across the three tiers of government, including but not limited to data collection and management, coordination, capacity development, quality assurance, and protection of statistics. A strong coordination mechanism is urgently needed in order to clarify responsibilities and avoid duplications.

An emerging group of private firms and nonprofit organizations are contributing to a nascent yet emerging data community in Nepal. Citizen-generated data and private sector data also proved to be important data sources to generate near real-time measurement of the displaced population in the immediate aftermath of the 2015 Gorkha earthquakes. In the aftermath of the devastating earthquakes in 2015, Flowminder, a Swedish nonprofit company, used Ncell’s aggregate and anonymized call detailed record (CDR) data to create a map of population movements. Near real-time and locally disaggregated measurement of population movements after natural disasters provided critical information about displaced populations, who are often vulnerable and in need of support.

Development partners play a significant supporting role in Nepal’s data ecosystem. There are at least 14 multilateral and bilateral agencies providing support to more than 25 public agencies in Nepal in the area of data and statistics. They conduct a significant number of surveys on their own. Some development partners have already started supporting provincial and local governments, and this trend will likely increase in the future.

At the same time, the dearth of data is already surfacing as a challenge for many prominent federal initiatives. Fiscal equalization policies achieved through intergovernmental fiscal transfers rely on a heavily data-driven scheme, but so far it still relies on some data collected pre-federalism. The National Data Profile (NDP), an open data platform to disseminate data from all relevant sectors across all three tiers of government, faces similar challenges, and it could only draw on its 2011 Population and Housing Census data at the time of writing. Localization of Sustainable Development Goals also needs more and better data, and the National Planning Commission (NPC) already produced 120 provincial-level indicators, but not at the local level.

Data needs of local governments are even more diverse, as are the local development challenges and priorities. Metropolitan cities like Kathmandu and Lalitpur would need data for urban planning, much like other metropolitan cities in other countries. Many rural municipalities likely need basic demographic and socioeconomic indicators to set baselines. The way data are communicated must be carefully customized to local contexts because the capacity to understand data is extremely diverse. The need to grow capacity to use data is echoed across the spectrum of the data ecosystem.

Nepal needs a data ecosystem that can fill the demand for reliable data from users within and outside of government. Most of the focus thus far was on data production. Without improving data sharing and data use, however, additional data production will not contribute much to the growth of the ecosystem. Realizing this vision will be a long journey. Strategic planning and investments under strong leadership are of utmost importance. Given the cross-cutting nature of data, much deeper coordination will be needed across government agencies, the private sector, civil society, media, academia, and development partners. The recommendations in this update are organized around two broad themes: (1) making the most of existing data, which focuses on short-term priorities; and (2) creating an enabling environment to nurture the data ecosystem, which mainly consists of long-term reforms.

Making the most of existing data would entail creating a more balanced data ecosystem across data production, sharing, and use. Since Nepal already has a lot of data, efforts around future data production should prioritize:

·      Continued and successful implementation of existing core statistical activities. The National Economic Census 2018 was a major accomplishment for Nepal. The 2021 Population and Housing Census offers an important opportunity for Nepal to establish statistical benchmarks for the central, provincial, and local governments. The core statistical activities will need to be reinforced to remain authoritative data sources and to serve the purposes of subnational jurisdictions to avoid parallel data collections.

·      Developing a long-term data production schedule for national censuses and surveys. Such a schedule would help avoid bunching of large-scale data production activities as observed in recent years. The government should use it to plan ahead of time and to strategically align donor support to ensure that these core activities cater to the data needs of the country over the long run. Given the intensive support by development partners in this area, development partners’ coordination is critical. It will help provincial and local governments to plan to satisfy specific data needs not addressed by the federal government.

[1] World Bank 2018a.

[2] United Nations 2014, page 4.

Last Updated: Dec 20, 2019



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