September 2011
Nepal Economic Update
Poverty Reduction and Economic Management, SAR
The World Bank
Summary Political uncertainties continue with serious inter and intra-political party disagreements, and transition to peace and writing of the new constitution are proceeding slowly. The new prime minister appointed on August 29 expressed commitment to expediting the process, and expectations are building up. Political uncertainties are adding to the already poor investment climate. Economic issues are on the backburner, and growth is slow particularly with the poor performance of nonagricultural sectors. Inflation remains high—near double digit—with the legacy of past monetary expansion, imported inflation, and Nepal’s own domestic price pressure because of high remittance inflows. High civil service wage hikes are also adding to inflationary pressure Fiscal prudence has been maintained in a difficult environment. Revenue performance has so far been commendable, but there are now emerging risks of prudence being jeopardized. Risks include revenue erosion because of a weaker economy and, as remittance growth gets slower as the base has expanded. Compliance may be becoming a major issue as significant VAT evasions are reported. On the expenditure, additional spending needs may arise from army integration and the needs to address financial sector weaknesses. The quality of expenditure remains an issue of utmost importance with limited implementation capacity, still-to-be-addressed PFM issues, weak MTEF implementation, and a rapid increase in transfer payments that are difficult to monitor. External balance has become more fragile and volatile than earlier with losses in international reserves experienced for the first time in years. The financial sector continues to experience liquidity shortage and remains vulnerable. NRB in response has been strengthening capacity for supervision and regulatory enforcement. But social indicators are improving rapidly; the latest Nepal Living Standard Survey indicates a significant reduction in both poverty incidence and income inequality—this is seen in large part due to the high level of remittance inflows that may exceed 25 percent of GDP. The outlook is that of elevated uncertainties for economic development. Action by the newly formed government is awaited.
Introduction 1. The parliament approved the extension of the term of the Constituent Assembly (CA) for a third time on August 29th. This time the extension was for three months till November 30th, 2011. Although much progress has been achieved in the writing of the new constitution, the Growth Rate assembly is yet to come to an 7.0 agreement on how to move to 5.8 6.0 federalism. CA members and 5.0 5.0 stakeholders spent much of the time 4.1 4.0 3.5 3.4 3.3 provided by the last extension (May3.1 3.1 2.6 3.0 2.4 August 2011) on managing the political 2.0 transition while some progress was 1.2 1.4 1.0 made on the path towards integration of 0.0 the two armies. A new prime minister Agriculture Industry Commercial Services GDP th was elected on August 29 who is Conflict ( FY 2002 ‐ FY 2007) Post‐ conflict (FY 2007‐ FY 2010) FY 2011 committed to expediting the peace process, complete the constitutional writing and provide relief to the people. Percent Change With most political leaders focused on 7.0 political aspects of the transition, 6.0 5.8 economic matters and issues of 5.0 4.8 investment climate are on the 4.1 4.0 3.5 3.3 backburner. 3.0 3.0
The Economy Real Sector
2.0
1.8
1.0
1.0
1.3
0.0 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11
Agriculture, forestry and fishing
2. The economy continues to suffer from political uncertainties.1 Real GDP grew by 3.5 percent in FY11 GDP Composition In FY11 (As percent of GDP) below the 5 percent average achieved during FY07-10 but slightly above the 3.1 percent average of the intense Financial intermediation Transport, storage and 4% communications Real estate, renting conflict period (FY02-06). The FY12 8% and business Manufacturing activities and Industry growth rate is likely to remain below 4 8% 15% Hotels and restaurants percent as performance of the non2% agriculture sector (industry and Services Total Agriculture, Wholesale and 50% forestry and fishing services) is projected to remain poor. retail trade Education & 35% 14% Health These sectors are being adversely 12% Public affected by political uncertainties, the Administration and defence poor law and order situation, militant 2% labor problems, and other governance issues. A liquidity crunch in the financial sector (along with underlying sector vulnerabilities) and delayed budget implementation have also affected non-agriculture sectors seriously. 1
Fiscal year starts mid-July. 1
3. Good weather is supporting robust agriculture growth. Agriculture contributes 33 percent of GDP. Favorable weather prevailed in FY11, and the sector grew by 4.1 percent, up from 1.3 percent in FY10. Also in FY12, timely rains have improved paddy production (which contributes 17 percent of agriculture value added), and, if the winter crop’s performance is as good, the agricultural growth target of 3.7 percent should be achievable this fiscal year as well.
Industry Growth by Sub‐Sector (percent change) 15.0
10.0
5.0
0.0
4. The service sector’s performance is faltering which is worrisome as it contributes 36 percent of GDP. Although it was the main growth driver during FY07-10 with an average of 6 percent annual growth, its performance weakened to 3 percent in FY11. Slower remittance growth in part contributed to the liquidity shortages at financial institutions, reducing new credit extension—lowering both real estate transactions and prices (see the section on the financial sector). With slower increase in remittance and with the steam off the real estate boom2, wholesale and retail sale contracted by 0.2 percent as money became dearer, and with slower growth of real disposable income (GDP plus transfers or gross national disposable income, GNDI) of 2.8 percent in FY11 (down from 4.3 percent in FY10, and 10.2 percent in FY08), consumers became more conservative. One bright spot has been the rebound of tourism sector, achieving 7 percent growth second year in a row.
‐5.0 FY05
FY06
FY07
Manufacturing
FY08
FY09
Electricty gas and water
FY10
FY11
Construction
Monthly Remittance (In US $ million and percent) 3500.0
60.0% 3183.2
3000.0
49.7%
2838.9
50.0%
2453.3
2500.0
2000.0
30.0%
27.1%
1500.0
In percent
In Millions US $
40.0% 1930.7
20.0% 15.7%
1000.0
12.1% 10.0%
500.0
0.0
0.0% 2008M11
2009M11
Monthly
2010M11
2011M11
Growth Rate
* Monthly data comprises of exchange rate on a monthly average middle rate basis. Source: Ministry of Finance and NRB
Real growth rates of GDP and GNDI FY05‐11 (In percent change) 12.0
10.0
5. The industrial sector’s continued poor performance is of concern. It grew by 1.4 8.0 percent in FY11— compared to an average 6.0 growth rate of 1.2 percent in the previous three years. The sector’s contribution to GDP 4.0 declined to 14 percent from 17 percent ten years earlier. The poor performance is due mostly to 2.0 the sluggish manufacturing sub-sector—which 0.0 grew by 0.3 percent a year during the last 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10R 2010/11P decade, and in fact has suffered from a negative GDP growth rate GNDI growth rate average annual growth of -0.3 percent since peace was achieved. In addition, during FY11, the electricity, gas, and water sub-sector contracted by 4 percent. Construction slowed down with 2
See September 2010 and April 2011 Economic Updates for the discussion on the real estate boom that took place in Nepal for the last several years. 2
softer remittance inflows, a tight credit situation, and low budgetary spending during the most of the fiscal year. The anti-money laundering regulations that require revelation of sources of funds in land transactions also adversely affected real estate and construction industry. 6. Consumption is still the main growth driver. Consumption growth has contributed to GDP growth significantly offsetting net export’s negative effects. Both investment and net exports contribute little to growth and is of concern in a country that needs infrastructure to facilitate and sustain 20 Real GDP growth decomposition by expenditure economic growth and unlock its potential. (in percent) 15 10 5 0 FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
F10
F11
‐5 ‐10 ‐15 Consumption
Gross fixed capital formation
Exports
Imports
GDP growth
CPI Nepal and India (y‐o‐y percent change) 25.0
20.0
15.0
10.0
5.0
FY2009
Nepal Food
Nepal Non‐Food
Jun
May
Jan
Apr
Feb
Mar
Dec
Nov
Jul
Oct
Sep
Jun
FY2010
CPI India Industrial
Aug
May
Jan
Apr
Feb
Dec
Mar
Nov
Jul
Oct
Jun
Sep
Aug
May
Jan
Apr
Feb
Mar
Dec
Oct
FY2008 Source: NRB and RBI
Nov
Aug
Sept
Apr
July
May
June
Jan
Feb
March
Oct
Dec
Aug
Nov
0.0 Sept
7. Remittance growth remains slow lowering disposable income growth. In FY10, officially recorded remittances were equivalent to 20 percent of GDP and are estimated to be at a similar level in FY11. In nominal terms, growth3 has slowed down sharply to 12 percent in FY11 from a high of 49 percent in FY08 affected in part by a slowdown in the global economy and political unrest in the Middle-East. The slower official remittance growth may also reflect diasporas holding on to their earnings given political uncertainties and limited investment opportunities at home and preference by many to use non-formal channels to remit money.4 With lower official remittance growth and the slowing down of GDP growth, GNDI growth slowed significantly as discussed above. This has had a number of implications on the economy. First of all, this has slowed consumption, lowered import growth, and, as a consequence, lowered revenue collection. It has also contributed to a reduction in land transaction adversely affecting the quality of assets at some financial institutions especially those highly exposed to the realty sector.
FY2011
CPI Nepal
3
Eleventh month data (y-o-y). The total remittance is estimated at 25-30 percent of GDP—as flows from India could add about 4 percent of GDP to official remittance and inflows through hundi and hand-carried money could add another 2-3 percent. As the stock of migrants abroad seems to be still rising (as departures rise), migrant workers’ foreign earnings must be rising as well. Relatively subdued official remittance growth could mean migrant workers are sending a smaller portion of their earnings and/or remitting and more through informal channels. The slowdown in wholesale and retail sub-sector—including low sales of new motor cycles—could be implying the total inflows are also subdued. 4
3
8. Inflation has been in the low double digits but has recently come down to below 10 percent. Price movements in Nepal have largely mirrored India’s because of the open border between the two counties. In Nepal monetary stance cannot sustain prices that differ from Indian prices for a long time as price differentials cause smuggling; changes in monetary stance eventually shows up in the changes in international reserves. Inflation is now at 9.6 percent (annual average CPI, based on 11-months data in FY11) similar to FY10 but down from 12.6 percent in FY09. Inflation has been high because of imported Indian inflation, high international commodity prices. Nepal’s own transportation and distribution rigidities often add to price fluctuations especially for foods in the hills and mountains. Wage increases have also contributed significantly to inflation (see below). While Indian inflation was higher than Nepal’s for the most of FY11, prices on both sides of the border have recently converged–again, reflecting open border and the pegged exchange rate.
4
Overall Balance in percent of GDP
2 0 2001/02
2002/03
2003/04
2004/05
2005/06
2006/07
2007/08
2008/09 2009/2010
‐2
Est. 2010/11
Budget 2011/12
‐4 ‐6 ‐8 ‐10 Overall balance before grants (fiscal) ( deficit )
Domestic finance net
Primary Deficit
Deficit financing (In percent of GDP) 9.0
9.0
8.0
8.0 1.07
7.0 0.21
6.0 0.14
4.0 3.0 2.0 1.0
0.19
0.35
2.11
2.17
1.4
2.67
2.49
4.70
2006/07
2007/08
2008/09
Domestic Financing ( net)
18.0
4.0 2.0
3.1
2.2
2.8
2009/10
2010/11 (est.)
2.1
1.0 0.0
‐0.02 2005/06
5.0 3.0
2.0
1.5
3.20 2.94
0.0 ‐1.0
6.0
0.04
5.0
7.0
Grant
2011/12 (Budget)
‐1.0
Foreign Loan (net)
Revenue Structure Disaggreagted ( as GDP Percent)
16.0 14.0 12.0
9. Food prices have driven inflation. 6.9 Inflation in Nepal is spearheaded by food 6.7 6.6 5.9 5.3 4.9 4.8 4.6 4.5 prices, which makes up 47 percent of the Consumer Price Index. The largest increases were seen in vegetable, fruit, sugar, and milk prices which increased by 47, 28, 23, and 17 percent (12 months), respectively, as of the end FY11. Cereal and grain prices increased about 10 Revenue and Remittance (In percent of GDP) percent. The timely and good monsoon 25.0 seen in 2011 will increase FY12 outputs, 20.0 with the possibility of lowering the 15.0 pressure on food prices in the near future. Despite this generally positive trend, parts 10.0 of the country may still face a food deficit 5.0 due to inaccessibility associated with 0.0 limited infrastructure development. 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 (est.) Workers' remittances Revenue Compared to food price increases, nonfood and services prices remained relatively stable, with only a 4 percent increase in FY11. The prices for petroleum products and coal rose by 13.4 percent (12 months) at the end of FY11. 10.0
8.0 6.0 4.0 2.0 0.0
2004
4
2005
2006
2007
2008
2009
2010
2011 Est.
2012 Budget
Income tax
Vat
International Trade tax
Excise
Others
International Trade Tax( incl. Vat and Excise ‐trade taxes)
10. Real wages continue to rise, and have been accommodated by monetary easing since early FY11, adding to inflationary pressures. Wages have been rising faster than consumer prices; the wage index rose by 31 percent y-o-y in FY11 (measured in mid-June). Agricultural labor wages rose fastest, at 40 percent, followed by regular worker wages (33 percent) and wages for construction workers (30 percent). Large scale outflow of migrant workers and the resulting worker shortages also explain the wage increases. In addition, huge remittance inflows in the recent past have increased aggregate demand (i.e., consumption) without raising the nation’s production capacity. This has added upward pressure on wages and inflation. Finally, FY12 budget has increased civil service salaries by 32 percent. Similar salary increases can be expected in the private sector with a lag of a few months. These will place further pressure on inflation.
Fiscal Year 2012 Budget Numbers at a Glance ( percent of GDP) 2011 2012 2008 2009 2010 estimates budget Total revenue 12.9 14.2 15.2 15.4 16.2 Tax Revenue 10.4 11.8 13.6 13.7 14.0 Non Tax Revenue 2.5 2.4 1.6 1.7 2.2 Grants 2.5 2.7 2.9 3.2 4.7 Expenditure Current Capital Expenditure
17.4 11.2 6.2
20.0 12.9 7.0
20.2 12.9 7.2
21.5 13.6 7.9
24.1 14.6 9.5
Financing Foreign Loans ( net) Domestic Borrowing (net)
2.1 0.1 2.0
3.1 0.0 3.1
2.2 0.0 2.2
3.0 0.2 2.8
3.2 1.1 2.1
Transfer Spending (In pecent of GDP) 10
8.9
9
8.9
10 9
8.1
8.0
8
8
7
7
6
5.3
5.6
6
4.6
5
4.1
4 3
1.9
2.3
2.4
5 4
3.3
3.2
3
2.3
2
2
1
1
0
0 2005/06
2006/07
2007/08
Capital Formation
Fiscal Management
2008/09
2009/10
2010/11 (est.)
2011/12 (Budget)
Transfer ( current and capital)
Aid (In percent of GDP) 7
7
6 6 11. A prudent macro fiscal stance has been 5 5 sustained in general, but there are signs of 4 4 emerging problems. Fiscal prudence, as 3 3 measured by net domestic borrowing (NDB), 2 2 is estimated at 2.8 percent of GDP for FY11 1 1 compared to the targeted 2 percent (seen as 0 0 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 ‐1 ‐1 the sustainable level).5 Both revenue and (est.) (Budget) expenditure were below targets. Larger Grant Foreign Loan (net) domestic financing reflects low revenues and low external financing due in part to the government’s limited implementation capacity and in part to donor concern over fiduciary risks. Aid absorption in FY11 was 3.4 percent of GDP, up slightly from 3 percent in FY10, but far below 6 percent targeted in the budget. The average aid disbursement during FY01-11 was 2.6 percent of GDP.
12. Revenue target was missed for the first time in four years. Revenue grew by 1 percentage point of GDP a year for the last four years, a commendable performance. But the FY11 target of 16.2 percent of GDP was missed by 0.8 percent of GDP. This was due to a number of factors: (i) lower economic activity on account of tight private credit conditions and slow capital budget implementation through most of the fiscal year; (ii) subdued remittance growth which slowed import growth—as revenue is now highly import-dependent (40 percent of total revenue amounting to 6.7 percent of GDP is trade 5
The period average NDB level was 1.8 percent of GDP (FY 2001 to FY 2011) and below the agreed macro fiscal framework target of 2 percent of GDP. 5
related)6; (iii) many exemptions and tax incentives introduced in FY11; and (iv) large scale VAT evasion by many taxpayers including major business houses. With aid disbursement lower than budgeted, the lower revenue contributed to the high domestic borrowing discussed above. 13. The increase of public expenditure is driven by current expenditure. The government spending has increased by more than 4 percentage points of GDP to 21.5 percent in FY11 from 17.4 percent in FY08. The current spending has increased by 2.4 percentage points to 13.6 percent while capital expenditure rose by 1.7 percentage points to 7.9 percent. But when only fixed capital formation (e.g., building physical infrastructure/buildings) is considered, the spending fluctuated between 2-3 percent of GDP without an upward trend (chart).
Private credit growth and interbank interest rates ( in percent) M2 growth
Weighted Average Interbank Transaction Rate
Private credit growth rate
35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 FY2004FY2005FY2006 07M3 07M6 07M9 07M12 08M3 08M6 08M9 08M12 09M3 09M6 09M9 09M12 10M3 10M6 10M9 10M12 11M3 11M6 11M9 11M11
14. Transfer payments have become the main method of budget disbursement. Transfer payments, both capital and current, started to increase in FY09 and are now a major mode of government disbursements; these payments were 9 percent of GDP in FY11, or 35 percent of public spending (chart). They are not monitored well, and this reduces budgetary transparency significantly. About 60 percent of transfer payments are budgeted as current—and the rest capital, but because actual spending is not monitored, the meaning of these classifications is limited. In addition, transfers include, for example, teacher salaries that are not classified as salaries; the accuracy of budgetary information on functional spending also suffers.
Money growth (In y‐o‐y percent change) 30.0 25.0 20.0 15.0 10.0 5.0 0.0 Jan Mar May Jul Sept Nov Jan Mar May Jul Sept Nov Jan Mar May Jul Sep Nov Jan Mar May 2008 Source:NRB
2009
y‐o‐y percent c hange
2010
2011
6
This is because, in addition to tariff collection, 60 percent of VAT receipt is on imports and nearly half of excises are on imports. 6
15. The FY12 budget was announced in July.7 However, there is a risk of fiscal stress. The revenue target is 16 percent of GDP – a 0.8 percentage point increase from estimated FY11 collections. Meeting this target is a challenge as the economic growth rate is projected to remain sluggish with slow remittance growth and banks’ continued liquidity problems that limit private credit expansion. Furthermore, many exemptions and tax incentives to investors and exporters (announced in the FY11 budget) will continue to reduce revenues. In addition, the government is committed to maintaining balance-of-payment surplus. The only way to achieve this, given the poor export performance and subdued remittances, would be to contain the size of imports. This could jeopardize revenues as revenue is highly import-dependent. At the same time, the budgeted expenditure is 24 percent of GDP. It includes the 32 percent hike in civil service wages as discussed above—but does not include some of the anticipated outlays associated with the political transition such as the cost of army Social Sectoral Expenditures (As percent of GDP)
Economic Sectoral Expenditures (As percent of GDP)
12
8 7
10
6 8
5 4
6
3 4
2 1
2
0
0 2003
2004
Education
2005
Health
2006
2007
Drinking Water
2008
2009
Local Development
2010
2011(est)
2012 (budget)
2003
Other Social Sectors
2004
2005
2006
2007
Agriculture
Irrigation
Forestry
Industry
2008
Roads
2009
Power
2010
2011(est)
2012 (budget)
Other Econic Sector Sectors
integration and ex-combatant rehabilitation. In addition, there can be contingency needs for financial sector weaknesses. Furthermore, the government has not implemented automatic oil price adjustments – and continued large NOC deficits are anticipated. Fiscal management would be challenged by such additional costs. 16. Aid is again projected to be 6 percent of GDP in the budget but actual disbursements are likely to remain closer to the FY11 level as absorptive capacity remains limited. It is however reported that officials are looking into offers from neighboring and other countries of additional aid funds to support development efforts and the peace process. 17. On the allocation of spending, economic sector spending has come to prominence for the first time since peace was achieved, while spending in key social sectors are protected. Budget allocation to economic sectors increased to 7 percent of GDP from 6 percent in FY11. The allocation rose significantly for the roads and power sectors. For the roads sector, rural roads remain a priority but the largest increase was for “rehabilitation”, an ambiguous spending category that needs clarification. In the power sector, focus is on the expansion of transmission networks. Investment in irrigation, at less than one percent of GDP, is unlikely to contribute significantly to increased food production. Education and health sectors dominate social sector spending – together 60 percent of the total 10 percent of GDP allocated for social sectors in the budget. The stated priorities in the education sector are for the expansion of the secondary education and girls’ education. For the health sector, the priority remains firmly on providing basic health care services. 7
Budget announcement was delayed by four months in both FY10 and FY11. This was the first time in three years that the budget was announced and approved on time. 7
Private credit growth and interbank interest rates ( in percent)
Nepal and India: Interbank rate (In percent) 15.00
Private credit growth
M2 growth
Weighted Average Interbank Transaction Rate
35.0
35.0
30.0
30.0
25.0
25.0
20.0
20.0
15.0
15.0
10.0
10.0
5.0
5.0
10.00
5.00
0.00 Jan Mar May Jul Sept Nov Jan Mar May Jul Sept Nov Jan Mar May Jul Sep Nov Jan Mar May ‐5.00
2008
2009
2010
2011
0.0
0.0 2003/04 2004/05 2005/06** 2006/07 2007/08 2008/09 2009/10
‐10.00 Nepal Real interest rate
Nepal Interbank rate
11M1
11M2
11M3
11M4
11M5
11M6
11M7
11M8
11M9 11M10 11M11
FY2010/11P
India Interbank rate
Monetary Trends
Monthly Gross Official Foreign Exchange Reserve and Reserve Coverage FY09‐FY11 (In US $ Million)
3500.0 8.7 8.7 8.8
8.1 8.1
3000.0
9.0 7.6
8.0
7.3 6.8
2500.0 In US $ Million
10.0
8.4 8.5 8.5 8.3 8.3 8.2
6.6 6.1 6.2
6.2 5.8
6.6 6.3 6.5 6.3 6.3 6.5 6.5 6.3 6.3 6.1 6.0 6.0 6.0 6.0 6.0 6.0
7.0 6.0
2000.0
5.0 1500.0
4.0
In Months
18. The monetary stance has changed during the year. Accommodative monetary policy was maintained during the earlier part of FY10 and contributed to credit expansion and prolonging of the real estate boom. The relatively easy monetary stance during the period of rising uncertainties about the real estate cycle led to noticeable capital flight. The combination of easy money and capital flight led to the erosion of international reserves (see Nepal Economic Update of April 2011). The monetary stance was reversed toward the end of calendar 2010, in part automatically as reserves declined. Reserve money growth came down to 3 percent by January 2011 (from 12 percent in July 2010), and broad money growth decelerated to 8 percent from 14 percent during the same periods. Interest rates rose above Indian rates and both imports and capital flight slowed significantly. The loss of international reserve has been reversed.
3.0
1000.0
2.0 500.0
1.0 0.0
0.0 Aug Sept Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec Jan Feb Mar Apr May Jun FY09
FY10
FY11
Gross Official Foreign Exchange Reserve
Merchandise
Nepal: Central Bank Net Lending to Commercial Banks (In percent of commercial bank assets) 5 4 3 2 1
2011M5
2011M4
2011M3
2011M2
2011M1
2010M12
2010M11
2010M9
2010M8
2010M7
2010M6
2010M5
2010M4
2010M3
2010M2
2010M1
2010M10
2009M12
8
2009M11
0 2009M10
19. The monetary stance has been eased again since early 2011. This was in response to increased strains in the
financial sector as liquidity shortages emerged and some small institutions requested NRB assistance. Overdraft lending to banks increased and other means of liquidity injection also rose. Liquidity assistance was provided through newly established financing windows (initially without a penalty rate and later with a penalty rate of 3 percentage points). The cash reserve requirement was reduced from 5.5 percent to 5 percent. As a result, interbank rates among category A banks declined to the low single digit levels, much below Indian rates. However, smaller financial institutions (categories B and C) continue to suffer from tight liquidity position and pay higher interbank rates. 20. The monetary stance remains relatively Total Credit and Deposit of Commercial Banks (In Rs. Billions) 800.0 lax. To maintain macroeconomic stability, 700.0 interest rates often need to be slightly above 600.0 Indian rates. This would help protect both 500.0 the international reserves and the currency 400.0 300.0 peg with the Indian currency.8 The current 200.0 level of liquidity injection to the banking 100.0 sector has the potential to accommodate 0.0 large price and cost increases, risking inflation and capital flight—jeopardizing the international reserve position. Total Deposits LCY Total Credit Source:NRB
21. Monetary policy in FY12 aims to achieve and maintain financial sector stability. The Central Bank has set a target of 12.5 percent money growth, 7 percent inflation, a balance of payments surplus of Rs 5 billion and maintaining foreign exchange reserve target at 6 months of imports. To meet the above targets, it has lowered the Cash Reserve Ratio (CRR) by 50 basis points to 5 percent to improve liquidity position of financial institutions (as discussed above). It has also allowed non-resident Nepalese to maintain foreign currency accounts, has made it mandatory for commercial banks to insure smaller individual depositors, allowed banks to issue loans in foreign currency in the priority sectors, offered tax incentives to encourage the merger of financial institutions, strengthened the monitoring and supervision of financial institutions, and announced stronger measures to deal with financial institutions that knowingly flaunt governance related rules.
Total Non Performing Loan(NPL) of all Commercial Banks of Nepal (In Percentage) 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% FY07 FY07 FY07 FY07 FY 08 FY 08 FY 08 FY 08 FY 09 FY 09 FY 09 FY 09 FY 10 FY 10 FY 10 FY 10 FY 11 FY 11 FY 11 FY 11 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Source:NRB Note:‐Total NPL Percent is Based on Gross Loan of Banks.Also,NPL is on the basis of weighted average.
Non Performing Loan(NPL) To Total Loan
Real Estate Exposure (In NRs billion) 120 100 80 60 40 20 0 Jul‐09
Oct‐09
Jan‐10
Total Real Estate
Apr‐10
Jul‐10 Real Estate
Oct‐10
Jan‐11
Apr‐11*
Jul‐11
Personal Home Loan
Financial Sector
8
The Nepali Rupee is pegged to the Indian currency at NPR 1.6 = IC 1.0. The peg has played an important role as a nominal anchor for Nepal. 9
22. The financial sector has come under stress since late-2009 with liquidity shortages. Earlier credit expansion during the real estate boom was followed by slower deposit growth due to a number of factors including the new rule to disclose income sources for depositors. The rapid credit growth and slower deposit growth raised credit-to-deposit ratio (CDR) to an unprecedented level of above 90 percent on average, and resulted in a slowing or Remittances ,Trade Deficit and Gross Official Reserves decline in credit extended by many different ( as percent of GDP) types of financial institutions. Commercial 30.0 banks, in particular, found it increasingly difficult to extend fresh credit to their clients. 25.0 Borrowers started to experience debt servicing 20.0 problems as rollovers became difficult. 15.0
23. The liquidity position of the financial sector remains tight, but it is improving gradually for commercial banks. CDR of the banking sector is 88 percent, slightly below the level seen during the same review period in FY11. The liquidity position of commercial banks (category A) has improved and their CDR has declined from 81 percent in April to 77 percent in July, 2011. Commercial banks are benefitting from the deposit growth of the last quarter of FY11 - from increased budgetary spending around the end of fiscal year and deposit shifting from B and C category institutions as a flight to perceived quality occurred. Commercial banks also took a cautious new lending stance and managed to tighten their exposure to the real estate sector. Category B and C financial institutions, however, still face tight liquidity.
10.0 5.0 0.0 FY 02
FY 03
FY 04
FY 05
FY 06
FY 07
FY 08
FY 09
FY 10
‐5.0
2010
2011
First eleven months Worker remittances
Current account balance
Reserves, net change
Trade deficit incl. sevice
Montly Remittances Inflows and Movement of Migrant Worker's 30.0
50000 45000
25.0
In Billions of NRs
35000 30000
15.0
25000 20000
10.0
5.0
Number of Migrant Worker's
20.0
40000
15000 10000 5000
0.0
0
Source:NRB
24. Real estate credit has stopped expanding. Riding high on remittance inflows, accommodative monetary policy, and the need to improve bottom line, commercial banks’ exposure to real estate rose and is estimated to be more than Rs. 95 plus billion, out of Rs. 580 billion of commercial bank credit to the private sector. The reported level of non-performing loans (NPL) among commercial banks is 3.3 percent although there is a perception by market participants that the real NPL level is higher. External sector 25. Trade deficit is a quarter of GDP. Despite a slowdown in import growth and modest gains in exports, trade deficit was still a quarter of Nepal’s GDP in FY11 and is expected to remain in that range in FY12. Imports were almost 30 percent of GDP and exports 5 percent in FY11. The current account deficit was 0.9 percent of GDP, down from 2.4 percent in FY10. Four import items (petroleum, vehicles, billets, and machinery) made up 35 percent of total imports, or 9.4 of GDP. Petroleum products made up more than one third of the imports from India; and one-fifth of overall imports in FY11. The other significant import items were cars (10 percent) and M.S. billets (9 percent). Import growth is particularly strong in products that are associated with remittance receipts such as construction related goods and household durable commodities.
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26. Exports have revived but not enough to cover the import of petroleum products. Export earnings are sufficient to fund only one-third of petroleum imports. Nevertheless, external sector performance has improved in FY11 as export growth picked up and import growth stabilized. Exports increased by 8.5 percent while import growth moderated to 6 percent growth rate in FY 2011 (based on 11 months data). Nevertheless it needs to be taken into account that the improvements in the trade balance were partly due to base effects; in FY10 exports had declined by 10 percent while imports increased by 34 percent. 27. Over 1000 people per day job seekers migrate overseas. During the last twelve months (May 2010May 2011), about 400,000 Nepalese left the country to find work abroad. But the growth rate of migrant departures is slowing: between mid-2009 to mid-2010 migrant departures doubled, while in the comparable period in 2011 the growth rate was 22 percent (see chart). The growth of remittance of about 10 percent in FY11 and in FY10 is a sharp deceleration from the 30 percent growth rates of the previous two years. The year-on-year growth of monthly remittance flows is trending down from the all-time high values of 2008. However, other high-migration countries (such as Bangladesh) have been affected more adversely by global recession. If mature migration counties such as the Philippines are seen as a guide: the growth rate of remittance flows to Nepal should stabilize in the medium run (see chart). National Living Standards Survey 28. The results of the third National Living Standards Survey (2010) suggest a substantial decline in poverty and an improvement in income equality. This was corroborated by findings of significant improvements in key non-consumption indicators. Between 2003/04 and 2010 there was a marked improvement in the well-being of households in the bottom 50 percent of the consumption distribution. Household consumption grew by more than 4 percent per year in real terms for those in the lower half of the distribution. Consumption grew for those in the upper half of the distribution as well, but at a slower pace. The improvement in wellbeing, as measured by consumption, was matched by improvements in other dimensions as well. For example, the percent of households with access to electricity almost doubled in this period, increasing from about 37 percent to 70 percent. Similarly, the share of households with access to drinking water (piped to the house) increased from 14 percent to 22 percent.
Outlook Monthly migrant departures from Nepal
Monthly remittance inflows y‐o‐y growth (percent)
45 40 35 30 25 20 15 10 5 ‐
80
150%
70 60
100%
50 40
50%
30 20
0%
10 0
May‐11
‐10 Jan‐08 Feb‐08 Mar‐08 Apr‐08 May‐08 Jun‐08 Jul‐08 Aug‐08 Sep‐08 Oct‐08 Nov‐08 Dec‐08 Jan‐09 Feb‐09 Mar‐09 Apr‐09 May‐09 Jun‐09 Jul‐09 Aug‐09 Sep‐09 Oct‐09 Nov‐09 Dec‐09 Jan‐10 Feb‐10 Mar‐10 Apr‐10 May‐10 Jun‐10 Jul‐10 Aug‐10 Sep‐10 Oct‐10 Nov‐10 Dec‐10 Jan‐11 Feb‐11 Mar‐11 Apr‐11 May‐11 Jun‐11
Jan‐11
Mar‐11
Jul‐10
Sep‐10
Nov‐10
May‐10
Jan‐10
Mar‐10
Jul‐09
Sep‐09
Nov‐09
May‐09
Jan‐09
Mar‐09
Nov‐08
Jul‐08
Sep‐08
Jan‐08
Mar‐08
May‐08
‐50%
migrant departures (thousand)
bangladesh
right hand side: y‐o‐y growth of migrant departures (percent)
Source: Nepal Department of Foreign Employment, Ministry of Labor
11
nepal
phillipines
Source: World Bank Migration and Remittances Group
29. Nepal’s outlook remains uncertain; it is hard to predict how the ongoing political transitions to peace, to a republic, and to federalism will unfold. In the meantime, law and order problems will likely remain in various parts of the country, and industrial relations will continue to be difficult; a number of enterprise closure as a result of aggressive labor movements have been reported. 30. Political issues still dominate policymakers’ debates, and insufficient attention is given to economic issues. As a result, rapid improvement in investment climate does not appear forthcoming. The financial sector’s weaknesses are likely to persist unless strong action is taken to improve supervision and regulatory enforcement; private sector credit may not recover soon suppressing growth. Infrastructure bottlenecks will remain unaddressed as the government’s implementation capacity would not improve in the near future. Also, the country’s external competitiveness has been eroded with, among others, intense wage pressure associated with declining labor force (because of largescale outmigration) and huge remittance inflows that fuel consumption. The real exchange rate has already appreciated by 20 percent from 2005. A quick turn-around in exports seems unlikely. 31. There are also positive developments. Despite emerging risks, it is expected that prudent fiscal management will be sustained given the strong commitment of the government and its good track record. The remittance, which has helped improve the country’s social, poverty, and inequality indicators significantly, is expected to continue to do so. Remittance growth is projected to stabilize at around 10 percent. Among non-agriculture sectors, tourism is doing well, and its good performance will likely continue if stability can be maintained for foreign visitors. Another positive aspect could be Nepal’s growing large neighbors, India and China. Demand from the rising middle class of these countries could revitalize Nepal’s export activities—but so far, the response to the neighbors’ demand appears to be coming largely from the informal sector. 32. All these lead to an expectation of relatively weak growth of at most 4 percent for the foreseeable future. As we expect continued fiscal prudence, inflation will likely be in line with the projected Indian level. One hope is that of accelerated political transition that could reduce uncertainties rapidly. The new government that came to power at the end of August is committed to an expeditious implementation of the peace agreement and writing of the new constitution. It also promises to address the economic development issues seriously. Some observers are cautiously optimistic.
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