Tuesday, August 29, 2017

NEPAL: Macroeconomic outlook for FY2018

The previous blog post covered the major macroeconomic highlights in FY2017. This blog post will provide an outlook for FY2018 (mid-July 2017 to mid-July 2018). 

GDP growth

The government’s GDP growth target is 7.2%, up from a 6.9% growth (at market prices) in FY2017 thanks to a favorable base effect, good monsoon, improved energy supply, reconstruction activities and normalization of supplies after two years of disruption (earthquakes in FY2015 and trade blockade in FY2016). Achieving a higher growth rate in FY2018 would require stronger factors than in FY2017. However, this is an unlikely scenario. 

First, the base effect will dissipate fast and there won’t be any fluke in FY2018 (at least as of now). Second, the usual factors that underpin robust economic activities are not as strong as in FY2017. 

Monsoon arrived not only late, but there was also uneven rainfall across the country. There was at least a week of dry spell during the peak paddy planting time. Then incessant rain, caused by a cloud burst, in the second and third weeks of August led to widespread flooding and landslides, wreaking havoc in the Terai plains (which is also considered a breadbasket of the country). In fact, according to Ministry of Agricultural Development, paddy plantation rate was 92.8% (1.4 million hectares out of 1.6 million hectares of cultivable land) in FY2018 (as of August 2017). In FY2017, it was 97% and paddy production was a record 5.23 million tons. Therefore, agricultural output growth will most likely be lower than in FY2017. Additionally, flooding has affected livestock and fishery. 

Although reconstruction activities are expected to accelerate (distribution of second and third tranche of housing grants), stimulating construction and mining and quarrying activities, manufacturing output may still be affected by the uncertainty over uninterrupted energy supply and the damage caused by flooding and landslides. The prospect of load-shedding is high in FY2018 as there has been setback to temporary plans to plug energy demand and supply gap. Higher energy import from India is likely as additional electricity generated by new small and medium scale hydroelectricity projects won’t be sufficient. Furthermore, floods have damaged and disrupted manufacturing activities in the main industrial belt. Against this backdrop, even industrial output growth will likely be lower than in FY2017. Accelerated reconstruction work and completion of large infrastructure projects, if realized within FY2018, might help to keep industrial output growth high.

The deceleration of remittances and temporary supplies disruption due to flooding and landslides will dent services activities. Tourism activities are beginning to pick up (tourist arrivals are up and bed occupancy is high ahead of the tourism season), but its momentum is slowed by the flooding in Terai (affected overland tourist arrival to hotspots in Terai such as Lumbini and Chitwan). Similarly, transportation activities are occasionally being disrupted along the main trading route due to landslides and weak management. Real estate and business activities may not pick up given the tight credit situation and regulatory squeeze. Wholesale and retail trading may not be as robust as in FY2017 as base effect related to supplies normalization fade away quickly and deceleration of remittance income weakens consumer demand (although post-earthquake housing grants, post-flooding reconstruction efforts, and elections related expenses may provide some backup). 

Against this backdrop, GDP growth (at basic prices) may hover around 5.2% (kind of optimistic one as of August 2017). Of this, contributions of agricultural, industrial and services sectors come to be around 1.2, 1.1 and 2.9 percentage points, respectively. However, given the uncertainty over the direction of some of the key factors (industrial activities and extent of damage caused by flooding) it is appropriate to consider a range for GDP growth forecast, which I think could be between 4.5% and 5.5%.


CPI inflation (FY2015=100) in FY2017 was 4.5%, sharply down from 9.9% in FY2016, thanks to bumper agricultural harvest, low fuel prices, low inflation India, improved energy supply (one of the main supply-side constraints) and normalization of supplies. However, in FY2018 inflationary pressures are likely to be high, especially coming from higher food and beverage prices. 

Food prices are expected to heat up as floods and landslides put strain on agricultural output and its distribution. Prices of cereals, vegetables and meat products will most likely grow higher than last year. Similarly, non-food inflation will also be higher than in FY2017, mostly coming from higher prices of clothing, housing and utilities, and transportation. Overall, elections (third phase of local election in province two on September 18, and provincial and federal elections in two phases on November 26 and December 7) related spending and disruptions caused by flooding in Terai will exert inflationary pressures on daily consumable and non-durable goods, and reconstruction works, if it accelerates, may increase demand for construction materials and unskilled and semi-skilled wages. Furthermore, CPI inflation in India (2012=100; fiscal year starts in April and ends in March) is also expected to be higher than in FY2017 (RBI’s target is an average 4%, but can tolerate a range of 2% to 6%). 

Accordingly, inflation may hover around 7.7% (in the neighborhood of NRB’s target of 7.5%), out of which contributions of food and non-food inflation would be 3.3 and 4.4 percentage points, respectively. As before, there remains substantial uncertainty over the intensity of the factors that drive inflation. Therefore, it is better to put up a range for inflation forecast, which I believe would be between 7.5% and 8.0%. 

External sector

A large increase in trade deficit coupled with deceleration/slow growth of workers’ remittances led to a current account deficit of about 0.4% of GDP in FY2017 (the first CAD since FY2011). In FY2018, this pattern will also probably remain the same. 

Nepal’s export is crippled by structural bottlenecks as well as supply-side constraints, and import demand of fuel and durables/construction materials is somewhat inelastic due to the wide gap between production and demand in the economy. Hence, trade deficit will further widen. Meanwhile, remittance inflows will decelerate or remain low as there has been a notable decline in the number of overseas migrant workers. Consequently, current account will likely remain in negative territory (around 2.2% of GDP or even higher).