development | FISCAL REFORM | remittance | FDI | PANDEMIC EFFECT | TOURISM |
With the onset of the covid-19 pandemic followed by restrictions in movements and slumping tourist arrivals, Nepal’s economy shrunk by 2.4% in FY20 for the first time in 40 years. The pandemic dealt a heavy blow to the progress made in poverty reduction and inequality, as the labour market was significantly affected. Many people lost their jobs, and the gender gap in employment widened.
As the severity of the pandemic faded, along with the rollout of vaccines, the economy began to recover from the pandemic-induced recession: it is estimated to have grown to 5.8% in 2022, up from 4.2% in 2021. The growth was largely buoyed by the strong recovery in domestic consumption and investments.
Household consumption rose by 1.1%, and private investments climbed by 3.2% in FY22, compared with the previous year, because of huge household savings accumulated during the pandemic and low rates. Public sector consumption also grew by 5.5% in FY22 due to salary hikes of civil servants, expenditures on local elections and imports of vaccines.
The service sector benefited from consumption demand as it grew by 5.9%, nearly reaching pre-pandemic levels. Higher investments meant the industrial sector expanded by 10.2%, up from 4.5% in FY21. This was mainly due to the addition of 738.6 MW of electricity to the national grid, including the 456 MW Upper Tamakoshi Hydropower Project.
Sectors which saw a decline post-pandemic
Despite a strong demand for consumption, production from agriculture declined from 2.8% in FY21 to 2.3% in FY22, following erratic rainfalls in October 2021.
Even as the recovery from the ravages of covid-19 has been rapid, job recovery has been slow and uneven. Of the 22% of people who lost their job in 2020, only 14% had found a new job by the end of 2021. 48% are earning less than what they used to before the pandemic struck. Women have regained 69% of the job losses while men have recovered 83%, worsening the pre-pandemic gender gap in employment.
Worse yet, soaring inflation threatens to undo the gains in earnings for many people, especially the poor and vulnerable. Inflation continues to rise — driven by transport costs, edible oil and housing prices. It was 6.3% in FY22, compared with 3.6% a year earlier. Global fuel prices increase led the highest rate of 10 years in Nepal with an increase in transportation sector prices with 16.1%.
What led to the import boom and pressure on foreign exchange reserves?
Though the economy grew after the pandemic on the back of increased consumption, it led to a huge surge in imports — reaching an all-time high of 43.4% of GDP at the end of FY22, 4.8% higher than a year ago — and in turn weighed on foreign exchange reserves. The jump in imports was especially led by higher commodity prices spurred by the Russian invasion of Ukraine and a 1.7% real effective exchange rate appreciation of the Nepali Rupee against the US dollar.
The import boom widened the trade deficit to all-time highs of 36.5% and the current account deficit to 12.8% of GDP. To stop soaring imports and falling reserves, Nepal followed a crude measure in April 2022 — banning imports of ten products, from motorcycles to mobile phones, that account for 4% of total imports. Moreover, the country introduced a measure that required importers of 47 products to park 50 to 100% of the imports’ value in bank accounts before receiving a letter of credit in order to kill imports. The ban was initially set to expire in July 2022. But now it has been extended to December 15th of this year.
Restrictions on imports are unlikely to alleviate external imbalances, though, as the infrastructural incapacity of the country and its geographical constraints will always be driving imports into the country. Instead, it is likely to lead to more price increases for banned products because of the supply-demand gap. It will also impact the economy because of the reduced liquidity of firms, which are required to deposit cash into accounts before importing. Finally, the banned items are subject to high import duties and accounted for 5% of total fiscal revenue in FY21. So the ban is likely to crimp the government’s revenue.
How did the government cope up with the economic structural imbalances?
Besides the import ban, the Nepal Rastra Bank increased its policy repo rate two fold to rein in credit growth (the main reason behind the ballooning imports). The policy repo rate was raised by 200 basis points in February 2022 and increased by another 150 basis points in August. But the increase in the policy repo rate was insufficient to reduce credit demand, leading to a juxtaposition between continued high liquidity demand and a reduction of loanable funds that resulted in a credit crunch.
In the coming year, the tourism sector is expected to bounce back, and the industrial sector will come out strong with increased hydroelectricity production. As fertiliser shortages continue, they will weigh on agricultural growth.
Inflation will soar and moderate in FY24 to 5.3% as commodity prices stabilise and a hawkish monetary policy is fully implemented. Changes in the fiscal deficit are projected as it falls from 3.4% of GDP in FY23 to 2.4% in FY24. Reasons could be attributed to ending covid-19 support measures, electoral spending and the government implementing revenue-enhancing reforms.
Remittances are expected to increase by 0.7 % of GDP between 2022 to 2024, reflecting increased out migration and exports. FDI is projected to remain low, leaving external borrowing and reserve drawdowns to continue financing the current account deficit. The world bank reckons that the growth is expected to be 5.1% in FY23 and 4.9% in FY24.
The macroeconomic impacts of climate change: A long-term projection
As one of the most climate change vulnerable countries in the world (Nepal ranks as the 10th most affected country in the world according to the Climate Risk Index), World Bank estimates that negative impacts are expected to accelerate sharply post-2050, with GDP contracting 24% relative to the baseline by 2100 through three channels of transmission (under the most pessimistic warming scenario).
GDP is expected to shrink by 4.9% through labour productivity, by 8.3% through agricultural activities by 8.3%, and by 12.9% through infrastructural impact of flooding.
Of the three climate shocks, flood damage on infrastructure — such as roads and buildings — is projected to have the largest macroeconomic impact — by reducing the capital stock, potential output, and production.
Combined, it is estimated Nepal will see an increase in the public debt to GDP ratio of 5.4% by 2100.
The road ahead
What the country should do to effectively manage external tensions instead of adopting unorthodox policies is expand upon tighter monetary policy already implemented and attract foreign direct investment for external financing.
First, Nepal must expand on restrained monetary (and fiscal) policies to manage the import demand — raising interest rates when needed, substantially scaling back refinancing facilities, reinstating banks’ regulatory provisions, and ensuring that fiscal spending does not excessively stimulate external demand.
Secondly, new methods to increase external financing, particularly FDI, should be introduced instead of relying on remittances, concessional loans, and service exports.
For a future resilient economy that accounts for the colossal future impact of climate change, the current economic model needs to change to achieve green, resilient, and inclusive development (GRID).
*This article is based on the report Nepal’s Economic Development 2022 published by the World Bank.
An annual development update, The Nepal Development Update, produced by the World Bank reports on key economic developments that occurred during the year, places them in a longer-term and global perspective, and examines topics of particular policy significance. It is based on the data released up until September 20, 2022. The report can be found here.
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