Nepal

Improved but still fragile growth momentum

Nepal’s economy slowed markedly in fiscal year 2023, having experienced a technical recession in the first half. This reflected the impact of higher international prices, import restrictions, reduced public spending, tighter monetary conditions, and political instability. In fiscal 2024, economic momentum is expected to improve. Spurred by increased emigration of Nepali workers, large remittances (22% of GDP) is expected to continue supporting private consumption, which is the cornerstone of domestic aggregated demand, at 86% of GDP. The number of Nepalese who received permits for foreign employment surged to a record high of 771,000 in FY2022-23. Coming mainly from the Gulf countries, India and Malaysia, expatriate remittances increased by 12.1% in USD in FY2022-23. In addition, the tourism sector (6.1% of GDP in 2022 and 6.7% in 2019) will continue to recover, helped by the gradual return of Chinese tourists (second in number of foreign tourists after India). This should, in turn, benefit transport, hospitality and food and beverage services. However, with global oil prices set to remain high in 2024, and the risks of higher food costs related to the El Niño phenomenon and the Indian export ban on non-basmati white rice, household spending will continue to be constrained by high imported costs. While back below the central bank’s target of 7%, inflation should therefore remain elevated. Despite this, the economy is likely to benefit from an easing in monetary policy. Nepal Rastra Bank slashed the cash rate from 8.5% to 6.5% in May and July of 2023. The central bank also relaxed provisions on working capital loans to revive investor confidence. Private capital formation should therefore drive activity after being the main drag on growth in FY2022-2023. The government’s plan to remove the minimum threshold on foreign investment in information and technology, as well as approval for the reinvestment of profit in Nepal, would help boost private investment. Meanwhile, public investment should rise after a dramatic fall (-20% y/y) in the past fiscal year. In addition to a recurrent lack of fertilizer, unfavourable dry weather is likely to crimp agricultural output in 2023 and 2024.

Fiscal deficit to decline amid prudent policy and the economic recovery

The current account deficit narrowed emphatically in FY2022-2023, helped by a notable reduction in the merchandise trade deficit and an increase in remittance inflow and tourism receipts. While widening slightly on the back of more robust demand which boosted the goods imports, the current account deficit should remain limited. The latter is financed by international financing - mostly long-term concessional loans - and by the foreign exchange reserves of the central bank, which remain high (12.5 months of imports as at mid-August 2023), allowing the currency to remain pegged to the Indian rupee.

The budget deficit is expected to narrow in FY2023-2024. The government passed a budget aimed at rationalising operating administrative expenses, while public revenues are expected to expand thanks to faster economic growth and the end of import restrictions which took a hefty slice off related public income until December 2022. This had a high impact on the budget balance in the previous fiscal year since this type of revenue contributes about half of total tax revenues. As a result of the public deficit, public debt will increase but remain manageable. Half of it is external but is owed to official development partners at concessional terms and is long-term.

Political instability continues to plague the country

Following a period of heightened political instability that started in December 2021 when the then Marxist-Leninist Prime Minister K.P. Sharma Oli tried to dissolve Parliament, general and provincial elections were held in November 2022. Almost half of the incumbent members of Parliament, including former cabinet ministers and party leaders, lost their seats. The vote resulted in a fragmented Parliament, with no single party or existing coalition able to secure a majority. After unsuccessful talks between the Nepali Congress’ (NC) outgoing PM Sher Bahadur Deuba – which secured the largest number of seats – and Pushpa Kamal Dahal, leader of the Communist Party of Nepal-Maoist Centre (CPN-MC), the latter made an alliance with Oli and the Communist Party of Nepal-Unified Marxist Leninist (CPN-UML). Dahal, commonly known as “Prachanda” was sworn in as Prime Minister on 26 December and easily won the vote of confidence in the following weeks (270 in his favour out of 275). However, Oli quit the coalition in February 2023, after PM Dahal supported the opposition coalition’s candidate from the Nepali Congress party (NC) for the presidential elections that were held in March. In the same month, Prachanda won a second confidence vote in Parliament (172 in favour vs. 89). Despite this victory, he struggled to form a new government amid dissatisfaction among the coalition partners, the main one being the NC. The stability of the government appears to be still fragile, with tensions within the latter party. Of interest, Deuba’s rival in the NC, Shekhar Koirala, has been openly advocating an alternative to CPN-MC to the faltering government.

Unlike his predecessor, Prachanda seeks balanced ties with China and India. Despite a territorial conflict, Nepal enjoys close ties with the latter and is the second-largest recipient of Indian aid. In August 2023, the two countries signed a preliminary agreement to increase Nepalese electricity exports to its neighbour. Meanwhile, Nepal is part of China's Belt and Road initiative. Unlike his predecessor, Prachanda seeks balanced ties with China and India. Despite a territorial conflict, Nepal has good ties with the latter and is the second-largest recipient of Indian aid. In August 2023, the two countries signed a preliminary agreement to increase Nepalese electricity exports to its Indian neighbour. Despite Nepal voting in favour of the resolution condemning Russia’s invasion of Ukraine in the UN, their relationship remains friendly. Nepal’s Assembly Chairman visited Russia in April 2023.

Last updated: October 2023