Wednesday, July 23, 2014

NEPAL: Major highlights of IMF’s 2014 Article IV report

Last week the IMF published a report based on its Article IV consultations in Nepal. The report is a useful document especially for update on overall macroeconomic performance, financial sector highlights and debt sustainability analysis.

Below are major highlights of the report:
  • Despite efforts to accelerate public spending, capital expenditure remains low.
  • Monetary policy in FY2014 remained loose.
  • Non-transparent implicit subsidies to NOC and NEA continued.
  • Macroeconomic outlook is broadly stable with 5% growth rate in FY2015.
  • Current account surplus may decline as remittance growth slows.
  • Medium-term prospects depend on improvements in investment climate— increase in capital spending to crowd in private investment, structural reforms in financial sector, and telecommunications, competition, labor market and business regulation reforms.
  • With limited global financial markets, external risks to outlook come mostly from the developments in the Indian economy.
  • Exchange rate appears broadly in line with fundamentals. But remittances are skewing domestic activities to non-tradable sand contributing to reducing the competitiveness of agriculture and industry.
  • The peg to the Indian rupee serves as a transparent anchor. An “engineered depreciation” or devaluation against the Indian rupee would in the short run likely to lead to additional remittance inflows, boosting international reserves and liquidity. But it would also trigger inflationary pressures. REER has broadly appreciated, but bilateral REER with India has depreciated by over 6% over the past decade.
  • Excess liquidity has undermined the conduct of monetary policy. NRB’s success have been modest in reducing this.
  • Directed lending to productive sectors forces banks to look for new investment opportunities. Cap on the spread between lending and deposit rates forces banks to improve efficiency. But, policies to direct lending and cap interest rate spreads are of limited effectiveness and can have unintended effects. Hence, it is better to review, modify and eventually phase them out.
  • Harnessing the financial sector and remittances to support economic growth is challenging.
  • Monetary policy should focus on controlling the volatility and level of excess liquidity in the banking system. It may require: (i) stepping up sterilization, and (ii) raising required reserves. The short-term fluctuations in excess liquidity is partly caused by uneven capital spending.
  • Monetary policy cannot compensate for the lack of infrastructure and other structural impediments to growth.
  • An interest rate corridor would further strengthen monetary management—limit interest rate volatility, facilitate liquidity management, and improve monetary policy transmission. Also would help in reducing interest rate differential with India and reduce incentives for capital flight.
  • Despite a large increase in bank branches over the last decade, access to finance remains limited.
  • Financial Sector Assessment Program (FSAP) identified significant financial sector vulnerabilities:
    • Bank supervision is largely compliance-based, fragmented and under resourced.
    • NPLs are likely underreported and widespread ever-greening.
    • Unsupervised cooperatives growing rapidly— partly fueled by directed lending practices