How is the economy performing so far? — A review

The Nepal Rastra Bank (NRB) released six months economic data of the ongoing fiscal year a while ago [seven months data is already out]. The period also coincides with almost a six month period since the incumbent Prime Minister of the country Khadga Prasad Oli assumed the office taking the helm from the previous government where it was the major alliance. 

The summary—

External indicators, fuelled by record-high foreign exchange reserves fuelled by rising remittance inflows fuelled by rising migration, continues growth. But the country’s internal sector continues its poor run.

Prices of essential items hit hard
One of the key aspects of analysing economic conditions — inflation, which directly impacts a wide range of economic factors such as purchasing power, cost of living and overall economic stability — slightly decreased to 5.4% compared to the last year in the same period.

But food prices have gone up by 7.2% with vegetable prices soaring by 28.5%, ghee and oil by 10.7%, pulses and legumes by 9.5% and cereal grains and their products by 7.2%. Whereas non-food inflation remained at 4.2%.

The rise in food inflation, especially for essential items like vegetables, cooking oil, and pulses and legumes, hits the poor and middle class the hardest. These groups spend a larger share of their income on basic food needs. Currently, 20.27% of the country’s population lives below the consumption expenditure of NRs 72,908.

Meanwhile, the country’s currency depreciated 2.83% against the dollar in the first six months of the fiscal year. The dollar index continues to rise and a strengthening dollar means Nepal faces the risk of higher import costs, inflationary pressures, shifting remittance inflows and rising costs in servicing its external debts in the coming days.

Strong growth in exports but not real
The good news is the country’s exports have increased by an impressive 31.8% to NRs 98.79 billion, compared to a 7.2% decline during the same period last year when the exports amounted to NRs 75 billion. 

Yet there is little rejoicing. 

Among the exports, soybean oil, a merchandise Nepal hardly commercially produces on its own, comprises the highest share — nearly one-fifth (19%) of the total exports. This export surged by an extraordinary 4,500% with all of it shipped to India. During the same period, the country imported soybean oil totalling Rs 24.37 billion.

And while Nepal’s total exports have jumped dramatically thanks to the Soybean oil, the country’s high-value exports outlined under the new five-year Nepal Trade Integration Strategy (NTIS 2023), which aims to diversify the country’s export products and markets, saw limited growth.

Among the leading exports items of the country — zinc sheets, juice, jute goods, ready-made garments, ayurvedic medicine, palm oil, and herbs experienced negative growth, while cardamom, polyester, woolen carpets, tea, oil cakes, textiles, rosin and shoes and sandals saw positive growth.

Exports to India grew by 46.1% and to China by nearly 20%, and to other countries by just 1%, indicating minimal diversification in export destinations.

The overall imports too have increased in the half year period by 7.1% to Rs 822.37 billion, which had earlier fallen by 3.1% (corresponding period). 

The share of intermediate goods was 50.2%, capital goods 8.8%, and final consumption goods 41% during the review period, with each category growing by 9.2%, 9.1%, and 4.2%, respectively. The rise in total imports and across all categories suggests a recovery in aggregate demand.

The country’s overall trade deficit remains massive, over seven times the size of its exports (NRs 723.58 billion), which increased by 4.4% compared to a decline of 2.6% during the corresponding period last year.

Strengthening external sector owing to ever-increasing migration
The balance of payment remained at a surplus of NRs 249.26 billion during the half year period. 

The country was able to attract only a modest foreign direct investment (FDI) during the period amounting to Rs 6.5 billion, an increase of Rs two billion from the previous period’s 4.5 billion.

On January 10, the government introduced a series of ordinances, including one on amending laws related to improving Nepal’s business and economic climate, which was wholeheartedly welcomed by industry associations. These ordinances were recently endorsed by both the houses [except for one]. 

However, it wasn't without controversy, as the government opted to enact it through an ordinance first rather than through proper legislative process, suggesting a greater focus on showcasing power and fuelling conflicts than on making the right decisions for the economy.

Before that it formed a five-member high level economic reform commission led by former finance secretary Rameshore Khanal. The assignment is yet to submit its final report.

The country’s biggest flex continues to be remittance inflows — reaching a total of NRs 763.08 billion in the six months period, marking a 4.1% increase compared to the previous fiscal year. This means the country is now receiving more than NRs 4.2 billion in remittances daily.

Although this overall growth is much slower than the 22.2% increase recorded during the same period last year. In dollar terms, the discrepancy is even smaller at 1.1% growth this six months, compared to last year's 19.5%.

This drastic shift raises many questions about what has disrupted the flow — Is it reaching a tipping point? Are remitters resorting to informal channels? Do changes in their socio-economic and financial conditions have anything to do with this sudden shift? Could shifting and volatile global politics and the growing tough stance on illegal immigrants in other countries, be a factor? Or is it just a one-time anomaly?

Whatever may be the answer, one thing is certain: the outbound migration from the country doesn’t seem to be slowing down any time soon. People are leaving the country in droves — which is poised to have substantial effects on the aggregate demand. In the last three fiscal years, around 2.5 million people have left the country seeking employment and educational opportunities, a trend likely to impact both workforce supply and domestic consumption and other economic effects.

Education-related travel payments alone were NRs 56.83 billion in the last six months, which was slightly higher (Rs 58.95 billion) in the previous corresponding period. The country also saw a total of NRs 101.92 billion in travel payments, reflecting a 9.7% increase.

Compared to the significant sums Nepalis are spending abroad on travel payments, tourism receipts were miniscule although it displays a positive trend. The country’s tourism income increased by 5.1% to NRs 41.86 billion in the review period which was NRs 39.82 billion in the same period of the previous year. 

A total of 1,147,567 tourists visited the country this 2024 — 132,685 more than the last year and the highest number of arrivals since the pandemic. This averages about 3,000 tourists daily. Last year, 1.01 million tourists visited the country, reflecting a 13.1% growth in 2024. Before the pandemic brought tourism to a halt in early 2020, Nepal welcomed almost 1.2 million visitors in 2019—indicating there is still significant progress to be made.

Growth in foreign exchange reserves but what to do with it?
The country’s gross foreign exchange reserves have increased by 13.5% to 2,316.84 billion since the start of this fiscal year. The NRB holds 89.4% of those reserves.

In US dollar terms, the reserves have increased to $16.84 billion, an increment by 10.3% from the previous period’s $15.27 billion.

The large foreign currency inflow is attributed to the growing remittance income which owes it to ever increasing outbound migration. 

As foreign exchange reserves have increased over the years, there has been a growing call to mobilise the surplus by establishing a sovereign wealth fund (SWF). The previous government introduced its intention to establish an SWF for investment in the public infrastructure and other productive sectors of the economy. The fund will be mobilised in different projects by creating special purpose vehicles (SPVs), this year’s budget announced. So far, nothing concrete has come out.

While growing exchange reserves are positive, they could also suggest stalled spending and investment.

Public finance continues to be plagued by its fiscal issues

In its mid-term review, the Ministry of Finance (MoF) continued with its past trend of slashing the budget — this year by NRs 167.5 billion — 9% of the initial allocation, suggesting unrealistic budget plans set each year. Budget cuts have become a norm now, with similar cuts happening the previous two years as well, reflecting weak economic leadership and qualification from successive governments. 

The [budget] reduction came amid failure to meet targeted expenditure and revenue collection, said Finance Minister Bishnu Prasad Paudel, addressing the Parliament on the review, while denouncing the former government although the current leadership was the largest coalition partner of the government at the time.

The country’s treasury was only able to collect 39.4% of the planned revenue and spend about 36% of the planned expenditure — out of which recurrent expenditure was NRs 452.55 billion (39.6%, including fiscal transfers) whereas capital expenditure was merely 16.2% (NRs 56.9 billion).

The revenue stress has such a strain on the treasury that Finance Minister Paudel immediately visited NEPSE seeking answers behind the slowing stock market, which had earlier soared with news emerging of the impending change in government leadership and Paudel’s return to the finance ministry.

Soaring public debt is another pressing issue, which has sparked debates whether the country should focus on loans or grants. This concern holds water as the country’s public debt repayment is almost twice its capital budget. 

Aids however won’t be easy in the coming days while the over reliance on aid needs rethinking. With Trump's presidency, the US’s focus on foreign aid cuts and pushing countries to increase defense spending will leave Nepal navigating a more unpredictable aid landscape. The US aid cut, which is vital to the country's healthcare system, will have immediate and significant effects. The $500 million MCC grant, which previously polarised the nation until its ratification and required navigating a difficult geopolitical dilemma, is also now in a state of uncertainty.

The country will also need to navigate complex diplomacy in the coming days — with shifting global dynamics and a more assertive approach from the US, which is likely to push India and China into more assertive diplomacy with Nepal in the coming days.

Meanwhile, India announced an allocation of INR 7.1 billion grant for Nepal in their budget this year. On the other hand, this early December, PM Oli and his counterpart, Chinese Premier Li Qiang, concluded an agreement on project-wise financing and development modality under BRI avoiding a wholesale package, on the sidelines of the bilateral talks between the two countries.

Monetary policy review and the financial system
The country's mid-term monetary policy review also paints a picture of a sluggish economy with its flexible monetary stance not being able to sufficiently nudge the domestic demand. 

Credit demand remained weak during the period. In the six month period, the financial regulator absorbed net liquidity of NRs 14,000 billion compared to the net injection of NRs 199.5 billion in the previous period. Credit to the private sector grew by an additional NRs 265.56 billion (5.2%) compared to 192.64 billion (4%) last fiscal year. These figures show a tremendous gap in the liquidity presently available in the system and credit demand.

Acknowledging the need to stimulate economic activity, the review opted for maintaining a "cautiously flexible approach" without intervening on the existing expansionary monetary stance.

And while credit has increased, rates have fallen, and liquidity has swollen, asset [credit] quality of the BFIs remains in question.

During this time, the NRB declared Karnali Development Bank to be in crisis and assumed control of its management, uncovering that its non-performing loans (NPLs) were as high as 40.9%, far worse than initially reported. Other development banks and financial institutions are also struggling with significant levels of non-performing loans, many surpassing 10%.

The country’s ‘A’ class commercial banks too are suspected of similar mismanagement. This second quarter, they reported NPLs at 4.5% compared to 3.4% the previous period. On this, the global lending agency and watchdog for financial stability, the International Monetary Fund (IMF) wants to recheck their financial health by auditing a sample of the 10 largest banks. 

In its latest review of the Extended Credit Facility (ECF) that the IMF has provided Nepal, the IMF once again highlighted the need for a Loan Portfolio Review (LPR) of the country’s ten largest commercial banks. The review had been stalled for a while now, but may finally kick-off with the NRB recently shortlisting six audit firms for the job.

Additionally, the country was recently greylisted by the Financial Action Task Force (FATF) for failing to do enough to combat money laundering and enforce strict oversight on financial crimes, including corruption, illicit acquisitions, dubious investments and tax evasion. This is the second time the country is greylisted since remaining in the greylist between 2008 to 2014.

The greylisting has come only months after the country’s first ever sovereign rating where it received BB- rating, which was a result of the country’s effort to to position the country as a viable destination for foreign capital.