Sunday, September 14, 2014

Nepalese economy in FY2014: Monetary sector

This blog post is adapted from Macroeconomic Update, August 2014, Vol.2, No.2. Here are earlier blog posts on real sector, fiscal sector, and FY2015 growth and inflation outlook.

I. Inflation

Although inflation (year-over-year average CPI) moderated in FY2014 compared to 9.9% in FY2013, it still remained elevated at 9.1% as the effect of the substantial moderation in non-food prices was partly neutralized by the sustained rise in food prices. Food and non-food prices increased by 11.6% and 6.8%, respectively. They increased by 9.7% and 10.1%, respectively in FY2013. Overall, while food prices contributed to 5.4 percentage points to overall inflation, non-food prices contributed 3.6 percentage points in FY2014 (Table 2). Despite the good agricultural harvest and moderating prices in India, the high food prices, which have a 53.2% weight in the overall CPI index, indicate domestic distortions in the food distribution system, and the high fuel prices and transport cost transmitted to wholesale and retail prices. The price of cereals and grains, vegetables, meat and fish, and fruits increased by over 10%, and together they contributed 4.1 percentage points to the overall inflation, and almost 76% of food inflation. The subsiding of non-food prices reflect the gradual strengthening of Nepalese rupee, despite it still being weaker than a few years back, as it closely follows the currency movement of Indian rupee vis-à-vis the dollar.

Table 2: Annual inflation (% change)

Inflation (Y-o-Y)
Year Average  Food Non-food
FY2010 9.6 15.1 4.9
FY2011 9.6 14.6 5.3
FY2012 8.3 7.7 9.0
FY2013 9.9 9.7 10.1
FY2014 9.1 11.6 6.8

Inflation has remained elevated due to a combination of structural bottlenecks, domestic supply-side factors, high inflationary expectations, and exogenous pressures such as the ongoing weakness of the currency despite some strengthening in the latter part of the year. Structural bottlenecks include weak backward and forward linkages, fragmented value chain and distribution systems, low productivity and policy inconsistencies. Supply-side constraints include the lack of adequate supply of electricity, transport bottlenecks, lack of raw materials leading to high import content of processed and light manufactured goods, and the inadequate supply of key inputs to boost productivity. Credible strategies to tame elevated inflation would help dampen inflationary expectations.

Inflation gradually increased from 7.9% in mid-August 2013, reached a high of 10.3% in mid-December, and then started to moderate, reaching 8.1% in the last month of FY2014. Compared to the prices in the corresponding months in FY2013, inflation was lower in all months except the last three months in FY2014 (Figure 21). Similarly, compared to prices in FY2013, food and beverage prices remained higher for all months except mid-August and mid-September (Figure 22). Non-food and services prices moderated in all the months compared to the level in corresponding months in FY2013 (Figure 23).

III. Money Supply

Money supply[1] (M2) grew by 19.1%, reaching NRs250.1 billion, on the back of a significant growth of net foreign assets[2], which compensated for the one percentage points slowdown in net domestic assets (Figure 25). M2 growth was 16.4% in FY2013 (NRs185.1 billion). The large net foreign asset holdings— registering a 27.2% growth (NRs127.1 billion) in FY2014, up from 18% growth rate in FY2013 (NRs68.9 billion)— were supported by a higher rate of remittance inflows and increased foreign assistance. The increase in money supply was reflected in the 17.7% growth of narrow money (M1) and 11.8% growth of time deposits. As a share of GDP, money supply, net foreign assets and net domestic assets stood at 81.2%, 31.1%, and 50.1%, respectively, in FY2014.

Net claims on government[3] — direct loans and government securities held by the central bank— decreased by 16.4% (NRs27.5 billion) from an increase of 3% in FY2013, reflecting the large increase in government deposits compared to the bank and financial institutions’ (BFIs) claims on the government. The overall credit to the private sector slowed down, registering a growth of 18.3% compared to 20.2% growth in the previous year. It indicates the lack of immediate bankable investment opportunities despite the declining lending rates offering by BFIs, which have had excess liquidity for over a year. As a share of GDP, total credit to the private sector stood at 7.3% in FY2014, down from 9.9% in FY2013.

IV. Deposit and Credit

The BFIs mobilized NRs218.7 billion (reaching a total of NRs1406.8 billion) in deposits in FY2014, higher than the NRs176.3 billion mobilized in FY2013, as higher remittance inflows and the acceleration of government spending in the last quarter of FY2014 boosted deposits. This translates into a growth of 18.4%, higher than 17.4% growth in FY2013. Deposit mobilization of commercial banks, development banks and finance companies increased by 17.8%, 29.1% and 5.7%, respectively (Figure 26). The cumulative deposit mobilization reached 72.9% of GDP in FY2014.

Total credit (loans and advances) of BFIs increased by 14.4% (NRs165.5 billion) in FY2014, down from 18.6% growth in FY2013 (NRs180.2 billion). Credits of commercial banks grew by 13.7% (NRs128.8 billion), down from a rate of 19.1% in FY2013. Similarly, credits of development banks and finance companies grew by 27% (NRs47.4 billion) and 4.3% (NRs3.9 billion), respectively (Figure 27). Credit to the private sector (by category A, B and C BFIs) increased by 18.7% (NRs176.1 billion), down from 20.8% growth rate (NRs162 billion) in FY2013, with commercial banks and development banks registering growth of 18.7% and 29.3%, respectively. Credit to private sector from finance companies declined by 2.1%. Despite the positive political outlook and declining lending rates, the growth rate of credit to the private sector fell due to the low demand emanating from the lack of immediate bankable investment projects and the cap on lending to certain sectors (particularly the property market) that had seen bubbles in the previous years. Cumulatively, 21.6% of the total lending went to wholesale and retail traders, followed by 19.6% to industry, 10.5% to construction, and 8.0% to finance, insurance and fixed assets (Figure 28). The total credit of BFIs reached 68.1% of GDP in FY2014.

On a sectoral basis, 25.8% of the increase in credit by BFIs was absorbed by wholesale and retail traders (NRs25.8 billion), followed by industry (NRs18.1 billion), construction (NRs13.2 billion), services (NRs15.8 billion), and agriculture (NRs11.1 billion) (Figure 29). While lending to construction sector is recovering after it hit a low in FY2011, lending to real estate has declined for two consecutive years (Figure 30) — reflecting the pickup in residential housing and infrastructure related activities, but a slowdown in real estate market.

V. Liquidity Management

In FY2014, the NRB mopped up a net liquidity equivalent to NRs602.5 billion through reverse repo auctions— one of the short-term tools used by the central bank to manage liquidity— at a weighted average interest rate of 0.16%, and NRs8.50 billion through outright sale auctions at a weighted interest rate of 0.05%. The central bank did not use reverse repo auctions in FY2012 and FY2013. However, it mopped up NRs8.5 billion at a weighted average interest rate of 0.97% in FY2013. The reverse repo auctions for eleven consecutive months and the declining rate shows the increasing appetite of BFIs to park their excess liquidity with the central bank as deposit growth outpaced credit growth. Accordingly, BFIs did not use the standing liquidity facility in FY2014. Despite the repeated bouts of reverse repo auctions, the declining interest rates, and the slowdown in lending growth, the continuing excess liquidity indicates structural issues in the banking sector.

To finance burgeoning imports from India, the NRB sold $3.14 billion in the Indian money market and purchased Indian currency equivalent to NRs308 billion. In FY2013, the NRB sold $3.12 billion to purchase Indian currency equivalent to NRs277.4 billion. The central bank also injected NRs343.5 billion into the banking sector by purchasing $3.52 from the commercial banks.

VI. Interest Rates

The excess liquidity, which peaked to NRs70 billion in November 2013 before declining to NRs40 billion towards the end of FY2014[4], throughout the year pushed short-term interest rates below 1% (Figure 31). The 91-day treasury bills weighted average rate was 0.25% in mid-August 2013, which declined to 0.02% in mid-July 2014 and averaged 0.13% in FY2014, much lower than 1.77% in FY2013. Similarly, inter-bank rate dropped from 0.3% in mid-August 2013 to 0.16% in mid-July 2014, and averaged 0.22% in FY2014, much lower than 1.77% in FY2013. 

The weighted average deposit and lending rates fell as the BFIs struggled to boost lending amidst excess liquidity (Figure 32). The weighted average deposit rate of commercial banks dropped to 4.09% in mid-July 2014 from 5.13% in mid-August 2013. It has fallen consistently from a high of 6.17% in mid-July 2012. Similarly, the weighted average lending rate fell to 10.55% in mid-July 2014 from 12.1% in mid-August 2013. The weighted average interest spread stood at 6.5% by mid-July 2014.

VI. Securities Market

The increasing investor confidence following the successful second CA elections in November 2013, lower deposit rates and excess liquidity in the banking sector significantly boosted stock market turnover, which peaked to NRs77.3 billion in FY2014 from NRs22 billion in FY2013 (Figure 33). The commercial bank’s share in total turnover was 65% (NRs37 billion). A higher share turnover indicates more liquid shares of a listed company. Note that Nepal’s share market is still developing and it does not always respond meaningfully to policy change and political developments.

The Nepal Stock Exchange (NEPSE) index reached 1036.1 in mid-July 2014, exactly double the index level of 518.3 reached in mid-July 2013. Stock market capitalization sharply increased to 54.8% of GDP in FY2014 (NRs1057.2 billion) from 30.4% of GDP in FY2013 (NRs514.5 billion). The total number of listed companies increased to 237 from 230 in FY2013, indicating the willingness of more companies to go public to raise capital and trade shares in the secondary market (Figure 34).


[1] Money supply (M2) is the sum of net foreign assets and net domestic assets. Also called broad money, M2 is equal to narrow money (M1,) and saving and time deposits. M1 is equal to currency in circulation and demand deposits.

[2] The balance sheet of monetary authorities is composed of assets and liabilities. Assets consist of net foreign assets and net domestic assets (net claims on government and claims on the private sector). Liabilities consist of currency issued and deposits. Both net foreign assets and net claims on government affect reserve money and hence the money supply. A decline in net foreign assets, denominated in local currency in the monetary survey, and the banking sector’s net credit to government reduces the money supply. Net foreign assets are associated with the fluctuations in foreign exchange reserves (in the balance of payments account).

[3] To facilitate the analysis of the central bank’s financing of government operations, claims on the government are recorded in net basis. The net credit to the government means creation of high-powered money, i.e. monetary base (currency in circulation plus reserves of banks in the central bank).

[4] IMF.2014. Nepal Article IV Consultation 2014. Washington, DC: International Monetary Fund.

Friday, September 12, 2014

Nepalese economy in FY2014: Fiscal sector

This blog post is adapted from Macroeconomic Update, August 2014, Vol.2, No.2. Here are earlier blog posts on real sector and FY2015 growth and inflation outlook.

I. Expenditure Performance

Despite the timely full budget, the expenditure performance in FY2014 was unsatisfactory. The CA II elections, budget execution delays, and long-running procedural and procurement hassles constrained absorptive capacities[1], resulting in lower than targeted capital spending. Much of the bureaucracy was assigned to conducting the CA II elections, virtually stalling the capital expenditure related procedural approval and procurement activities for about three months. The estimated actual capital spending was 74.9% of planned capital expenditure in FY2014, lower than the 82.6% achieved in FY2013[2]. Meanwhile, actual recurrent spending was 84.2% of planned recurrent expenditure, also lower than the 88.7% in FY2013 (Figure 8). Overall expenditure grew by 19.6%, with recurrent and capital spending growth at 20.2% and 16.7%, respectively— all higher than their corresponding growth rates in FY2013 (Figure 9).

Within recurrent expenditures, compensation of employees increased by 27.6% as a result of the hike in public sector employees’ salaries by 18% and an additional allowance of NRs1,000. Grant to local bodies, use of goods and services[3], and interest and services payments increased by over 20%, but subsidies[4] decreased by 72.7% (Figure 10). Overall, recurrent expenditures are estimated to be 16.4% of GDP, higher than 14.6% of GDP in FY2013.

Capital spending continued to be low as in the previous FY, reaching just 3.3% of GDP in FY2014— marginally higher than the 3.2% of GDP posted in FY2013 but much lower than the targeted 4.4% of GDP in FY2014 (Figure 11). Apart from the slowdown engendered by the CA II elections, other persistent factors impeding capital spending are: (i) lack of project readiness, in terms of timely preparatory activities such as detailed project design, land acquisition, establishment of project management offices and required personnel, and procurement plans; (ii) delays in project approval and budget release; (iii) delays in procurement related processes; and (iv) overall weak project planning and implementation capacity[5]. The country needs to drastically increase capital spending, both quantum and quality, to address the large infrastructure deficit (estimated to be between 8% and 12% of GDP annually until 2020), to set the foundation for graduation from LDC category to a developing country status by 2022[6], and to achieve other social development objectives that are curial for inclusive economic growth.

Within capital expenditures, land purchase declined by 48.2%, faster than the rate of decline in FY2013. It indicates the difficulties surrounding land acquisition for infrastructure projects. Spending on building construction, plant and machinery, and research and consultancy grew by over 20%. Vehicle purchase grew by a whopping 248.7%, which could partly be attributed to the low base effect. The expenditure for civil works increased by just 11.2%, reflecting approval and procurement related delays. Except for civil works— which was 2.3% of GDP, the same as in FY2012 and FY2013— none of the eight sub-categories within capital expenditures was above 1% of GDP (Figure 12).

As in the previous years, FY2014 saw bunching of spending, especially capital spending, towards the last few months. Almost one-fourth of actual total public expenditure was done in the last month and 42.4% in the last three months. Of the actual capital spending, 37.8% was spent in the last month and 58.8% in the last three months (Figure 13). This pattern of spending is not much different from previous years, irrespective of the timeliness of issuance of budget. It raises concerns about not only the absorptive capacity, but also the structural issues concerning budget execution as outlined above.

The ballooning recurrent expenditure is a matter of concern as it remained about NRs4 billion higher than tax revenue in FY2014. Furthermore, the growth rate of recurrent expenditure has been higher than the growth rate of tax revenue in the last three years. Rationalization of recurrent expenditures— a significant portion of these go to public sector salary, and pension and social security related obligations—is required for creating the fiscal space needed to boost allocations for capital expenditure. Although capital spending allocation can be enhanced through increased domestic/international borrowing in the short to medium-term, in the long-term strengthening revenue mobilization and recurrent expenditure rationalization will be needed so as to reduce the reliance on increased borrowing.

II. Revenue Performance

Total revenue grew by 20.6%, marginally lower than its 21.2% growth in FY2013, reaching NRs356.8 billion (18.5% of GDP). It is higher than the budget target of NRs354.5 billion, thanks to the significant increase in non-tax revenue, which partly offset the lower tax revenue growth. While non-tax revenue grew by 23.8% as opposed to a decline by 2.7% in FY2013, tax revenue growth slowed down to 20.1% from 25.8% in FY2013. As a share of GDP, tax revenue mobilization has improved significantly, reaching 16.2% in FY2014, up from 15.3% a year earlier (Figure 14). The continuous reforms in revenue administration, broadening of the tax base, and the higher import bill resulted in robust revenue performance. Some of the notable reforms undertaken in recent years include: (i) information and communication technology based tax returns filing and payments systems; (ii) establishment of a data link with the Company Registrar’s Office to enhance tax compliance[7]; (iii) measures to reduce tax compliance costs; (iv) strengthening of tax monitoring and audit systems; (v) measures to widen the tax net for various tax categories; and (vi) implementation of the Any Branch Banking System (ABBS) for large tax payers.

Revenue mobilization from all sources, except vehicle tax, grew in FY2014. The growth rate of value added tax (VAT), excise duty, land registration fee, and non-tax revenue was higher than in FY2013. They increased by 20.9%, 23.8%, 32.5% and 23.8%, respectively. Income tax and customs revenue increased by 16.3% and 19.3%, respectively, lower than 28.1% and 31.1% in FY2013 (Figure 15). The deceleration in VAT collections is attributed to the lower growth of VAT on production; goods, sales and distribution; and service and contracts. Overall, VAT contributed the largest (28.3%) to total revenue mobilization, followed by income tax (21.8%), customs (19%), and excise duty (12.7%) (Figure 16). Taxes on consumption and imported goods, which are largely financed by remittance income, constitute a lion’s share of total tax revenue mobilization—around 70%. Furthermore, import-based revenues (custom duties, VAT, and excise on imports only) account for about 45% of total revenue.


III. Budget Balance

The robust revenue growth combined with the lower than expected expenditure resulted in a lower than average fiscal deficit[8] equivalent to 0.1% of GDP in FY2014 (Figure 17). Though this is better than the fiscal surplus equivalent to 0.7% of GDP in FY2013, it is still lower than the medium-term average fiscal deficit of about 2.2% of GDP. For a low-income country with a large financing need to bridge the infrastructure deficit, particularly in hydropower and transport, running a modest fiscal deficit without jeopardizing fiscal sustainability is desirable. Nepal faces an estimated infrastructure financing gap of between 8-12% of GDP until 2020. The total net borrowing amounted to NRs26.6 billion in FY2014 (1.4% of GDP).

IV. Public Debt

Nepal’s overall outstanding public debt (external and domestic) has been steadily declining, reaching an estimated 30.1% of GDP in FY2014 (Figure 18). Total external debt decreased to 18.4% of GDP in FY2014 from 19.7% of GDP in FY2013. Similarly, total domestic debt declined to 11.7% of GDP from 13% of GDP in FY2013, reflecting the lower than targeted domestic borrowing as a result of the wide gap between actual and planned expenditure. External debt service payments stands at around 9.8% of exports of goods and non-factor services. The declining stock of public debt and debt service payments generally indicate prudent fiscal and public debt management.

V. Public Enterprises

The overall performance of public enterprises (PEs) improved in FY2013 as a result of the lower than expected losses of Nepal Oil Corporation (NOC) and Nepal Electricity Authority (NEA). Of the 37 PEs, 17 made losses and one did not make any transaction. 4 PEs that incurred losses in FY2012 earned profits in FY2013. Compared to a net loss of NRs 3.5 billion in FY2012 (0.23% of GDP), FY2013 saw a surprising rebound with an estimated net profit of NRs 11.4 billion (0.7% of GDP). This is largely attributed to the substantial reduction in losses of NOC and NEA (Figure 19). As a result of the decrease in prices of crude oil in the international market and an increase in administered fuel prices, NOC’s losses dropped to NRs2.1 billion in FY2013 from NRs9.5 billion in FY2012. Similarly, NEA’s losses dropped to NRs4.6 billion from NRs9.9 billion, thanks mainly to the increase in electricity tariff by 20%, decline in exchange rate losses by NRs220 million, and reduction in provisioning for employees’ expenditure by NRs740 million.[9] The combined losses of NOC and NEA amounted to 0.4% of GDP in FY2013, down from 1.3% of GDP in FY2012. Nepal Telecom’s (NT) profit of NRs11.3 billion in FY2013 (0.7% of GDP) compensated for most of the losses incurred by PEs. The government is projecting a decline in net profit in FY2014 due to the expected rise in losses of NOC and NEA (equivalent to about 0.9% of GDP).

The cumulative liabilities of PEs increased from 1.8% of GDP in FY2012 to 2.5% of GDP in FY2013 as a result of the rise in both unfunded and contingent liabilities. The unfunded liabilities (salary, pension, social security contribution, health care, and recurrent costs, among others, that the PEs cannot finance themselves) have increased steadily from 1.0% of GDP in FY2009 to 1.6% of GDP in FY2013. A major contributor to the rise in unfunded liabilities is the hike in salary and allowances in the public sector. Meanwhile, contingent liabilities (state guarantees of loans, defaults of PEs, and clean-up liabilities of privatized PEs, among others) also increased in FY2013 after a steady decline in the past four years. It reached 0.9% of GDP in FY2013, up from 0.4% of GDP in FY2012. These have contributed to the overall increase in the reported liabilities (Figure 20).

Either privatization or liquidation of loss making PEs needs to be accelerated to reduce the budget drain. The weak financial position of PEs has led to large unfunded liabilities, especially for pension and other related retirement benefits, which could ultimately become the government’s liabilities. It may be noted that due to the lack of accurate and updated data, the contingent liability of PEs presented here are at best conservative estimates. It is likely that the government is exposed to much higher level of liabilities. In this regard, fiscal and macroeconomic stability could potentially be subject to significant risks. Continuing the adjustment of electricity tariffs and adjustment of fuel prices to reflect the true cost of production will help to lower the losses and liabilities.

[1] Absorptive capacity generally refers to the skills mastered by bureaucracy, state of infrastructure, and quality of institutions.

[2] Due to the caretaker status of the then government and the lack of broader political consensus, a timely and full budget could not be introduced in FY2013. Instead, the budget was introduced on a piecemeal basis on 15 July 2012 (one-third of the actual expenditure in FY2012), 20 November 2012 (two-thirds of the actual expenditure in FY2012), and 9 April 2013 (a full budget consolidating the previous two partial budgets). The planned capital spending was NRs66.1 billion in FY2013, of which NRs54.6 billion was spent.

[3] Use of goods and services consists of (i) rent & services; (ii) operation and maintenance of capital assets; (iii) office materials and services; (iv) consultancy and other services fee; (v) program expenses; (vi) monitoring, evaluation and travel expenses; (vii) recurrent contingencies; and (viii) miscellaneous.

[4] Subsidies include direct subsidies to non-financial public corporations and private enterprises only. Actual direct and indirect subsidies are much higher. This does not include subsidies for chemical and organic fertilizer, micro-hydropower projects, transportation subsidy for seed and fertilizer supply, and interest subsidies to farmers groups and cooperatives, among others.

[5] The Commission for Investigation of Abuse of Authority’s (CIAA) pro-active monitoring of corruption in bureaucracy has also delayed decision making, especially those related to procurement.

[6] For a detailed analysis on prospects for Nepal’s graduation to a developing country status by 2022, see: ADB. August 2013. Macroeconomic Update. Vol.1, No.2, Manila: Asian Development Bank.

[7] The cost of collection per NRs1,000 decreased from NRs16.4 in FY2007 to NRs12.7 in FY2011.

[8] Fiscal balance is computed as expenditures (including net lending) minus revenue (including grants). However, normal fiscal balance (revenue minus expenditure and net financing) was a surplus equivalent to 1.3% of GDP.

[9] The high losses of NEA are attributed to the rising electricity import, which is sold at suppressed rates, from India, and the still large provisioning for pension and gratuity of employees. The average electricity import price is NRs8.4 per unit, but the retail price is NRs8.04 per unit. Nepal imports around 200 MW of electricity during the dry season.

Wednesday, September 10, 2014

Nepalese economy in FY2014: Real sector

This blog post is adapted from Macroeconomic Update, August 2014, Vol.2, No.2. Here is an earlier blog post on FY2015 GDP growth and inflation forecasts.

Gross domestic product (GDP) grew by an estimated 5.2% in FY2014, up from 3.5% in FY2013, as a result of the bumper agricultural harvest, moderate recovery in construction, and robust services activities backed by high remittance income (Figure 1). The services sector contributed about six-tenths of the GDP growth, largely coming from wholesale and retail trade; and transport, storage and communication activities. The agriculture sector’s contribution to the GDP growth stood at three-tenths and the industry sector contributed about one-tenth.

In the agriculture sector, which comprises almost 35% of GDP and provides livelihood to about 76% of households, growth rebounded to an estimated 4.7%, the highest in the last six years. The timely and favorable rainfall, and the adequate supply of agricultural inputs, including chemical fertilizers, boosted production of both summer and winter crops.[2] According to the Ministry of Agriculture Development, paddy production is projected to increase by 12%, up from a 11.2% decrease in FY2013. Similarly, maize production is estimated to increase by 9.9%, up from an 8.3% decrease in FY2013. Wheat production is projected to increase by 6.1%, up from 2.0% in FY2013. Paddy, maize and wheat accounted for 52.5%, 23.3% and 20.1%, respectively, of total cereal production in FY2013 (Figure 2).

The industry sector, which comprises a mere 15% of GDP, grew by an estimated 2.7%, marginally up from its 2.5% growth rate in FY2013, as construction, and electricity, gas and water grew modestly despite a slowdown in manufacturing. The timely budget and modest acceleration in actual capital expenditure (though still low compared to the planned expenditure) propelled construction activities growth to 2.9%, up from 1.9% in FY2013. Manufacturing activities grew by 1.9%, the lowest rate in the last five years, primarily due to the impact of long hours of power cuts, persistent supply-side constraints, and the rise in cost of production due to the increased prices of imported raw materials. Concrete, sugar, aluminum materials, vanaspati ghee, paper, biscuits and beer production fell by over 30% in the first two quarters of FY2014. The average capacity utilization of key industries remained at 49.9% in the first half of FY2014, slightly higher than the 44.7% capacity utilization recorded in the first half of FY2013.[3]

The remittance-induced consumption demand propelled services sector growth to an estimated 6.1%, the highest growth rate in the last six years. The services sector, which comprises about 51% of GDP, grew by 5.2% in FY2013. Within the services sector, wholesale and retail trade— whose share in GDP was 14.9% in FY2014, higher than the share of the industry sector— grew by an estimated 8.8%, two percentage points higher than in FY2013 (Table 1). Wholesale and retail trade’s contribution to GDP stood at 1.32% in FY2014, up from 0.98% in FY2013, reflecting the strong growth of remittance inflows, which boosted consumption demand of imported goods. The increase in the number of tourist arrivals and its positive impact on spending boosted hotel and restaurant activities by an estimated 7.1%, up from 5.5% in FY2013. Driven largely by the robust increase in communication related activities, the transport, storage and communication sub-sector grew by 7.5%, marginally up from 7.4% growth in FY013. The slow recovery of real estate, renting and business sub-sector, which grew by 3.0% from 2.7% in FY2013, reflected the tight sectoral credit policy imposed by the central bank on banks and financial institutions.[4]

Table 1: Sub-sectoral growth and share of GDP

  Growth Share of GDP
Sub-sector FY2013R FY2014P FY2013R FY2014P
Agriculture and forestry 1.1 4.7 33.5 32.6
Fishing 2.7 4.9 0.4 0.5
Mining and quarrying 3.3 3.7 0.6 0.6
Electricity, gas and water 0.3 4.8 1.3 1.2
Manufacturing 3.7 1.9 6.4 6.1
Construction 1.9 2.9 6.9 6.8
Wholesale and retail trade 6.8 8.8 14.5 14.9
Hotels and restaurants 5.5 7.1 1.9 2.0
Transport, storage and communications 7.4 7.5 8.9 8.7
Financial intermediation -0.9 1.8 3.9 3.8
Real estate, renting and business activities 2.7 3.0 8.8 8.4
Public administration and defense 5.5 5.7 2.0 2.4
Education 5.9 6.0 5.8 6.4
Health and social work 5.6 5.5 1.4 1.5
Community, social and personal services 4.6 4.7 3.7 4.1

Source: Central Bureau of Statistics

On the expenditure side[5], consumption accounted for an estimated 91.1% of GDP, up from 89.9% of GDP in FY2013 (Figure 3), indicating the increasing consumption demand stimulated by growing remittance income.[6] Gross capital formation stood at an estimated 37.1% of GDP, contributed mostly by the increase in gross fixed capital formation (GFCF) from 22.6% of GDP in FY2013 to 23.1% of GDP in FY2014 despite a decrease in stocks from 14.3% of GDP in FY2013 to 13.9% of GDP in FY2014. Public and private GFCF were an estimated 4.7% and 18.5% of GDP, respectively. Despite these high investment figures, the impact on growth and employment is pretty nominal, most probably due to the inefficiency of investment management arising from the lack of efficiency-enhancing prerequisites related to physical and social infrastructures, and the inability to unwind expenditures in underperforming and unfeasible projects.

Despite an increase in exports, the high import demand— backed by high remittance income in the absence of domestically produced alternatives—further widened net exports, reaching an estimated negative 28.2% of GDP in FY2014 from 26.8% of GDP in FY2013. The increase in price competitiveness as a result of the weak currency pushed exports of goods and non-factor services to an estimated 12.1% of GDP, up from 10.7% of GDP in FY2013. Meanwhile, imports of goods and non-factor services increased to 40.3% of GDP in FY2014 from 37.5% of GDP in FY2013. The major factors affecting supply capacity and cost competitiveness of exports sectors are: (i) lack of adequate and quality infrastructure; (ii) political instability and strikes; (iii) recurring labor disputes and low productivity; (iv) lack of skilled human resources; (v) deficient research and development investment and innovation in the private sector; and (vi) policy inconsistencies and implementation paralysis.[7]

Gross domestic savings declined to an estimated 8.9% of GDP from 10.1% of GDP in FY2013 and 14% of GDP in FY2011. It indicates that a majority of the residents’ income is spent on consumption, which is mostly fulfilled by imported goods. Meanwhile, the substantial increase in gross national savings— from 40.3% of GDP in FY2013 to an estimated 46.4% of GDP in FY2014— reflects the record high remittance inflows, which reached 28.2% of GDP in FY2014. It has also contributed to a positive savings-investment gap[8] (an estimated 9.4% of GDP in FY2014) in the last three consecutive years. Though per captia GDP increased to an estimated $713.8[9] in FY2014 from $709.5 in FY2013, it is still lower than $715.8 in FY2012 (Figure 4). The fluctuation in per capita GDP is partly attributed to the depreciation of Nepalese rupee against the US dollar. Reflecting the high per capita remittance inflows, nominal per capita gross national disposable income reached an estimated $981.6 from $923.7 in FY2013. Per capita GNI stood at $727.9 in FY2014. The size of Nepal’s economy expanded to an estimated $19.7 billion in FY2014, marginally up from $19.3 billion in FY2013.

Domestic investment commitment: Total domestic capital investment (fixed capital plus working capital) commitment increased remarkably by 142% in FY2014, up from a rate of 42% in FY2013. As a share of GDP, it reached 15% in FY2014, up from 5.5% in FY2012, largely due to an astounding 158% increase in investment commitment in the energy sector. Overall, of the total investment commitment of NRs289 billion in FY2014, 77.3% was in the energy sector, followed by construction (12.1%), manufacturing (6.3%), and tourism (2%) (Figure 5). As a share of GDP, investment commitment in the energy sector went up from 5.1% in FY2013 to 11.6% in FY2014, indicating the rising investor confidence emanating from the strong commitment by the new coalition government to introduce investor-friendly reforms in a range of sectors, including energy. Energy sector development is the top priority of the new government.

Foreign direct investment (FDI) commitment: FDI commitment, approved by the Department of Industry, reached NRs20.1 billion in FY2014, marginally up from NRs19.8 billion in FY2013 (Figure 6). It translates into a growth of just 1.5% compared to 115% in the previous year. Consequently, as a share of GDP, it stood at a mere 1.04%, lower than 1.2% of GDP in FY2013. That said, while the FDI commitment in manufacturing, mineral, service and tourism sectors decreased, the energy sector saw an impressive 306% growth, mostly coming from India and China—which together accounted for 91% of the total energy FDI commitment. Country-wise FDI commitment shows that the People’s Republic of China (PRC) surpassed India as the top FDI source country with a 36.4% share of total FDI commitment in FY2014. The other top FDI source countries are South Korea, Cook Islands, USA, Japan, British Virgin Islands, and Singapore— together accounting for about 20% of total FDI commitment. It may be noted that despite the increase in FDI commitment, actual FDI inflow, as per the balance of payments, significantly decreased from NRs9.1 billion in FY2013 (0.5% of GDP) to NRs3.2 billion in FY2014 (0.2% of GDP).


[1] R and P denote revised estimate and provisional estimate, respectively. Any reference to GDP for FY2013 and FY2014 in this Macroeconomic Update refers to revised and provisional estimate, respectively.

[2] Major winter crops are wheat, barley, potato, winter tomato, cauliflower and cabbage. Major summer crops are paddy, maize, millet, buckwheat and summer potato.

[3] Capacity utilization of key industries in FY2013 was 57.8%, the same as in FY2012.

[4] Responding to the busting of real estate and housing bubble, triggered by a decline in the growth of remittances in FY2011, and a build-up of non-performing loans, the central bank imposed a lending cap of 25% to this sector in FY2012. It contributed to the cooling down of prices in this sector.

[5] The GDP by expenditure data are prone to measurement errors as change in stocks is computed residually, which also includes statistical discrepancy/errors. Change in stocks was estimated to be 13.9% of GDP in FY2014. A large residual indicates that a significant portion of the GDP is either unexplained or could not be directly attributed to its components, i.e. consumption, capital formation and net exports.

[6] It may be noted that even though final consumption with respect to GDP is very high, the actual domestic consumption expenditure made up an estimated 62.9% of GDP in FY2014, down from 63.1% of GDP in FY2013 and 65.5% of GDP in FY2012. This is due to the surge in net exports (or export minus import) in FY2014, , i.e. the consumption expenditure on imports of goods and non-factor services.

[7] For more on Nepal’s export competitiveness, see the issue focus section of Macroeconomic Update, Vol.2, No.1, February 2014.

[8] Computed as the difference between gross national savings and gross capital formation.

[9] US$1=NRs98 in FY2014 and US$1=NRs87.7 in FY2013.

Monday, September 8, 2014

NEPAL: GDP growth and inflation forecast for FY2015

This blog post is adapted from Macroeconomic Update, August 2014, Vol.2, No.2.

GDP growth

The outlook for FY2015 is a bit less optimistic than that for FY2014, mainly due to the subnormal monsoon forecast and the likelihood of moderate El Nino conditions, which result in deficient rainfall and droughts. Not only did the monsoon rains arrive late this year[1], the overall rainfall also is expected to be lower— around 93% of the long term average[2]. This will potentially lower agriculture production in FY2015. It will be further exacerbated by the impact of natural disasters, particularly floods and landslides. However, with the gradual improvements in the political environment and the resurgence of investor confidence following the government’s commitment to unveil ‘second generation’ reforms to stimulate private investments, the industry sector s expected to perform much better than in the previous years. While he improved private sector confidence will likely boost manufacturing activities, the timely full budget with higher planned capital expenditures along with better project readiness, as well as increases in bank credit to personal housing may boost construction activities. The high inflow of remittances will continue to support robust service sector activities, especially wholesale and retail trade; transport, storage and communications; and real estate, renting and business activities.

Considering these developments, GDP growth (at basic prices) is forecast at 4.6% in FY2015, lower than both the FY2014 estimated growth rate and the government’s target of 6% set in the budget. Over six-tenths of the contribution to this growth rate is expected to come from the services sector, followed by one-tenth from the industry sector and the rest from the agriculture sector. Overall, the continuing robust services sector growth and a potential strong recovery of the industry sector will be partially offset by the anticipated decline in agricultural production, lowering the GDP growth rate in FY2015 compared to an estimated 5.2% in FY2014. In order to reach a 6% growth rate, assuming agriculture sector growth of 4.7% (which in reality in unlikely given the unfavorable monsoon), the non-agriculture sector has to grow by at least 6.7%, more than one percentage point higher than the growth rate in FY2014. Furthermore, assuming constant agriculture and services sectors growth as recorded in FY2014, the industry sector has to grow by a whopping 9% to achieve the government’s growth target. This would be challenging as industrial sector growth has averaged just 2.7% in the last three years.


The expected low agriculture harvest, potential rise in administered fuel prices and transport cost, increase in public sector salary and allowance for two consecutive years, and disruptions in domestic distribution systems as a result of natural disasters and strikes will likely push up general prices of goods and services to 9.5% in FY2015. Furthermore, the heightened inflationary expectations will potentially exert further pressures on prices, especially that of key food products and clothing imported from PRC. The unfavorable monsoon will not only lower production and put pressures on food prices, but it might also encourage hoarding of major food products, creating additional pressures and further heightening inflationary expectations. That said, there is a high likelihood of a moderation of prices that pass-through imported goods from India and third countries as the ongoing stabilization of foreign exchange markets and increasing investors’ confidence on the Indian economy—thanks to the anti-inflationary stance by Reserve Bank of India Governor Raghuram Rajan and the credible, investor-friendly government led by Prime Minister Narendra Modi— might result in strengthening of the Indian currency in FY2015. Food and beverage, and non-food and services will likely account for about 60% and 40%, respectively, of the overall CPI inflation.

[1] Monsoon rains were late by around two weeks. Normally monsoon rains enter on June 10 from the Eastern region, and gradually covering the entire country within a week. Approximately, 80% of total rainfall occurs between June and September.

[2] Indian Meteorological Department’s forecast in the second week of June 2014. Long term average refers to the 50-year average. For more, see:

Thursday, September 4, 2014

Global Competitiveness Report 2014-15: Nepal ranks 102 out of 144 countries

According to the latest Global Competitiveness Report 2014-15, Nepal ranked 102 out of 144 countries. This is an improvement from 117 in GCR 2013-14, and 125 in the two years before that.

In the three main components of GCI, Nepal ranks 100 out of 144 countries in basic requirements for competitiveness (institutions, infrastructure, macroeconomic management, and health and primary education); 115 in efficiency enhancers (higher education and training, goods market efficiency, labor market efficiency, financial market development, technological readiness, and market size); 124 in innovation and sophistication (business sophistication and innovation).

The major contributors to the improved overall ranking are good progress on macroeconomic management (rank 37), health and primary education (rank 75), and financial market development (rank 75). Within macroeconomic management, the major contributors are the low government budget balance (rank 11) and low public debt (rank 38). Within health and primary education, the major contributor is the high net primary education enrolment (rank 19). Within financial market development, the major contributors are financing through local equity market (rank 47) and legal rights index (rank 29).

[The numbers are impressive, but the mechanics of getting there is not that straightforward. For instance, the good budget balance is not due to impressive fiscal management, but because of the inability of the government to spend allocated money combined with robust revenue mobilization, thanks to rising revenue from taxes on imported goods financed by remittances. For a low-income country like Nepal, which has huge financing need to close the infrastructure deficit, running a modest fiscal deficit without jeopardizing fiscal sustainability and macroeconomic stability is generally a good option.]

Nepalese businessmen think that the top five problematic factors for doing business are government instability, corruption, inadequate supply of infrastructure, policy instability, and inefficient government bureaucracy.

Saturday, August 30, 2014

Financial stability in Nepal – 2014 v.1

The Nepal Rastra Bank (NRB) biannually publishes financial stability report (FSR), which comes out with a lag of about six months. The latest FSR reports developments up to mid-January 2014.

Below are key highlights of the report.

Financial system:

  • The financial system in Nepal consists of banking and non-banking systems. Banking system includes commercial banks, development banks, finance companies, and micro-finance financial institutions, and NRB permitted cooperatives and FINGOs. Non-banking system includes CIT, EPF, postal saving bank, insurance companies, cooperatives, Nepse, and merchant banking institutions.
  • These together total 285 BFIs and other financial institutions. BFIs total 211 and represent 88.7% of total assets and liabilities.
  • Total assets and liabilities of NBL, RBB and ADB— the three state-owned commercial banks— are equivalent to 15.9% of GDP. They serve 26% of total deposit account holders and 44% of total borrowers. Their combined branch network cover 33.9% of total commercial bank branches. However, they just have 80 ATMs.


  • Excess liquidity due to a surge in remittance inflows and the sluggish growth in private sector credit. It suggests a general lack of favorable investment climate.
  • Excess liquidity adding costs as banks have to pay interest on deposits, and hence are disinclined to lower lending interest rates.
  • Liquid assets to deposit ratio is higher than the regulatory requirement.
  • Repeated OMO through reverse repos and outright sale auction to mop-up excess liquidity not effective to resolve the issue beyond the short-term.
  • All BFIs restricted from accepting institutional deposit over 60% of their total deposit.
  • Prompt Corrective Action (PCA) now based on capital adequacy and liquidity situation. Liquidity Monitoring and Forecasting Framework (LMFF) covers class A, B, and C BFIs.

Non-performing loan (NPL):

  • Overall, NPL level is about 4.3%, but there are significant variations within BFIs. Total NPL of commercial banks and development banks stood at 2.6% and 4.6%, respectively by mid-July 2013. NPL of finance companies stood at 15.7%.
  • Real estate concentration is still high even though it is coming down as old real estate investments are gradually maturing. Residential housing loan is expanding.
  • 44.5% of total loan is backed by actual real estate.

Capital adequacy ratio (CAR):

  • Regulatory CAR for commercial banks, development banks and finance companies is 11%, 10% and 10%, respectively.
  • Regulatory requirement of paid-up capital is NRs2 billion, NRs640 million and NRs200 million for commercial banks, development banks and finance companies, respectively.
  • CAR of commercial bank stands around 11.3%. CAR of development banks and finance companies stand at 15.4% and 15.9%, respectively. It suggests that these are well capitalized.
  • Commercial banks and development banks are reporting under Basel II framework. Finance companies are following Base I format for reporting.

Financial stability:

  • BFIs are not adequately capitalized to absorb the shocks— hold higher percentage of deposits on their total liabilities portfolio.
  • Low business volume, rising funding costs, increased regulatory costs of higher capital requirements and liquidity buffers have become normal features.
  • Paid-up capital and total capital increased due to mergers, IPO issuance by new banks, and further increment in paid-up capital by banks.
  • As a share of GDP, total deposit and total credit have expanded. So has total credit to total deposit ratio, but this is still below the regulatory requirement, suggesting more room for BFIs to extend further credit for economic activities. But, credit to deposit ratio of B and C class institutions in totality exceeds the regulatory provision.
  • 22 commercial banks remain vulnerable in case of deposit withdrawal by 15% and more. Overall vulnerability test suggests that commercial banks are in less vulnerable position than other types of BFIs.
  • Only foreign banks and financial institutions can invest in shares of Nepalese banking sector. Foreign non-BFIs have to sell shares to Nepalese citizen or institution by mid-July 2015.


  • Lack of sound corporate governance practices, strong interconnectedness among financial institutions and promoters
  • Poor assessment of risks (credit, liquidity, foreign exchange and operation)
  • Growing risk from shadow banking activities.
  • BFIs failing to establish a sound link between risk management, capital structure and lending.
  • Lack of professional management, increasing unproductive assets, loan recovery problems, discouraging pay incentives, unsustainable profit targets, inadequate risk management practices, etc.
  • Sound regulatory and supervisory authority needed to control malpractices of cooperatives.
  • Stress testing mandatory for class A, B and C BFIs. It has to be reported back to the NRB.
  • BFIs need to audit their information system and submit audit report by January 2015.
  • No concrete provision to address interconnectedness so far. Interconnectedness occurring through inter-bank deposits and lending, investment by single promoter in more than one BFI, private placements, consortium lending, investment in government bonds, debentures, national certificate of savings, national debentures, etc.

Consolidation of BFIs:

  • Small and financially poor BFIs merging with stronger ones.
  • Moratorium on licensing of new Class A, B and C BFIs.
  • Merger promoted to lower operating costs, bring about economies of scale, and diversify market share. Following the merger bylaws, 55 financial institutions have merged with each other and formed 23 institutions.

Interest rates:

  • BFIs need to bring interest spread rate to 5% by FY2014. Base rate need to be reported by class A, B and C BFIs.
  • Inflation is eating up, on an average, 4% return on deposits, i.e. real interest rates have fallen.
  • The repo rate, 91-day T-bill rate, and inter-bank rate— important measure of short-term money market rate and indicate liquidity situation— remained low.