1

Asian Development Outlook (ADO) 2014: NEPAL

Chandan Sapkota Asian Development Bank Nepal Resident Mission

ADO launch (press conference), Kathmandu, 01 April 2014

The views expressed in this document are those of the author and do not necessarily reflect the views and policies of the Asian Development Bank, or its Board of Governors, or the governments they represent.

2014-04-01
2

Presentation Outline
FY2013 Economic Performance
GDP growth Inflation External sector Fiscal and monetary developments

FY2014 and FY2015 Economic Prospects

GDP growth Inflation External sector

Policy Challenge: Taming High Inflation Medium-term Economic Challenges

2014-04-01
3

FY2013 Economic Performance

Significant drop in agriculture output and the delay in introducing a full budget dragged down GDP growth. Inflation remained high. Current account surplus contracted as remittance inflows decelerated.
2014-04-01
4

GDP Growth (Basic Prices)

Supply-side contributions to growth
Services Industry Agriculture GDP

Percentage points
6 4.3 3.9 4 3.8 4.5 3.6

GDP growth decelerated to 3.6% in FY2013 Unfavorable monsoon Shortage of chemical fertilizers Delayed full FY2013 budget Weak industrial sector Growth driven by: Services sector (wholesale and retail trade; hotels and restaurants)

-2 2009 2010 2011 2012 2013

2014-04-01
5

Inflation
Inflation
% change 20 Overall Food & beverage Nonfood & services

15

Annual average inflation crept up to 9.9% in FY2013 Initially high food and nonfood prices Moderated in the later months of FY2013 Inflation driven by : Low agriculture harvest High food prices in India Rise in transport costs Supply-side constraints

10

0 Aug2010

Feb2011

Aug

Feb2012

Aug

Feb2013

Aug

Feb2014

2014-04-01
6

External Sector
Trade, tourism, and workers' remittances
Trade balance % of GDP 30 20 10 0 -10 -20 -30 2009 2010 2011 2012 2013 Remittances Tourism (travel) Current account balance

Current account surplus narrowed to 3.4% of GDP in FY2013 Deceleration of remittance inflows Increase in trade deficit BOP surplus moderated to $786.5 million Forex reserves increased to $5.6 billion Covers 9.3 months of imports of goods and services

2014-04-01
7

Fiscal and Monetary Developments

Fiscal indicators
Recurrent expenditure Revenue including grants
% of GDP
25 20

Capital expenditure Deficit

% change 35 30 25 20 15 10 5 0

Credit to private sector

15
10 5 0 -5

2009

2010

2011

2012

2013

2014BE

2009

2010

2011

2012

2013

Budget surplus: 0.4% of GDP

Total expenditure growth slowed
Delayed FY2013 full budget Weak implementation capacity

Consolidation of BFIs Credit to private sector increased

Largest credit increase to construction, wholesale and retail trade, services and mines Annual average weighted lending rate remained stable at around 12%
8

Actual capital expenditure just 81% of planned capital expenditure Strong revenue performance

2014-04-01

FY2014 and FY2015 Economic Prospects Economic outlook optimistic than FY2013
Successful second Constituent Assembly elections Favorable monsoon Strengthening of remittance inflows Improved business and investor confidence

Downside risk of political instability

Unsettled constitutional and governance issues

2014-04-01
9

GDP Growth Outlook for FY2014 and FY2015

FY2014: 4.5%
Favorable monsoon More rapid growth of remittance inflows Timely FY2014 full budget Political stability Improved business confidence

FY2015: 4.7%
Normal monsoon Timely full budget Continued strong remittance inflows Rebound of real estate and housing markets Better growth outlook in India

2014-04-01
10

Inflation Outlook for FY2014 and FY2015

FY2014: 10%
Wage pressures Higher administered fuel prices High inflation in India Weak currency Persistent energy deficit Supply-side constraints

FY2015: 9.5%
Good harvest Lower inflation in India Cautious monetary and fiscal policies Subsiding domestic wage pressures

2014-04-01
11

External Sector Outlook for FY2014 and FY2015

FY2014: 3.6% of GDP

Improved growth of exports Higher remittance inflows Higher tourism income

FY2015: 3.7% of GDP

Further pick up in exports growth Moderation in import demand Sustained remittance inflows

2014-04-01
12

Policy Challenge: Taming High Inflation

Average food and non-food inflation
Food & bevereges inflation Overall inflation % change Non food & services inflation

Age of high prices!

Average inflation > 9% since FY2009 (except FY2012: 8.3%) 12.6% in FY2009 highest in the past 2 decades Food inflation averaged 11.8% in the past 4 years

20
18 16 14 12 10 8 6

High costs of inflation

Erodes consumers purchasing power Makes producers less competitive

4
2 0

2014-04-01
13

Taming High Inflation: Drivers and Deviation

% change 20 15 10 5 0 -5 FY1995 FY1996 FY1997 FY1998 FY1999 FY2000 FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 FY2012 FY2013

Food inflation in Nepal and India

NEP (CPI) IND (WPI Food articles)

Drivers of inflation
Inflation in India
Largest trading partner Pegged currency Food inflation affected more

International oil price movements

Quickly increases cost of imported goods, chemical fertilizers and transportation

Weak currency (higher cost of imports) Wage pressures Agricultural output Supply-side constraints
Power outages Transpiration bottlenecks Market distortions

% change 12 10 8

Inflation in Nepal and India (3-year moving average)

NEP (CPI) IND (WPI)

6
4 2 0

Deviation from its usual path after FY2007

Inflation more responsive to changes in international oil price movements and nominal effective exchange rate Supply-side constraints keeping prices high
Market price distortions by syndicates and middlemen

FY2003

FY1997

FY1998

FY1999

FY2000

FY2001

FY2002

FY2004

FY2005

FY2006

FY2007

FY2008

FY2009

FY2010

FY2011

FY2012

2014-04-01
14

FY2013

Taming High Inflation: Policy Options

Monetary policies are less effective
Effect tends to fade away quickly

Rectify market distortions

Effective market supervision and monitoring

Ban syndicates and anti-competitive practices Check inflationary expectations

Prudent fiscal and monetary policies Remove uncertainty over supplies of fuel and cooking gas

Boost agricultural production Effectively address structural bottlenecks

2014-04-01
15

Medium-term Economic Challenges [1]

Fiscal management
Rationalization of recurrent expenditure Higher quantum and quality of capital expenditure Boosting overall absorptive capacity and effective budget execution Rationalizing fuel and electricity tariffs to reflect true import and production costs, respectively Good governance (sound PFM) Fiscal policy for inclusive growth:
Public expenditure have stronger impact on income distribution than changes in revenue Increase public spending on education and healthcare, targeted subsidies, and physical infrastructure Strengthened revenue mobilization financially enables government to take on the above measures

Improved investment climate

Enacting revised Electricity Act, Labor Act, Industrial Enterprises Act, SEZ Act, FITT Act, [PPP Act] Political and policy stability Adequate electricity supply Industrial relations and labor productivity

Financial sector stability

Consolidation of BFIs Enhanced monitoring, supervision and regulation (both BFIs and cooperatives) Rethinking directed lending Sound corporate governance Liquidity management

2014-04-01
16

Medium-term Economic Challenges [2]

Strong manufacturing sector and export competitiveness
Shift from low value added and low productivity activities to high value added and high productivity activities (manufacturing, high productivity agriculture and services activities) Boost export competitiveness by tackling supply-side constraints, namely lack of adequate and quality infrastructure, political instability and strikes, recurring labor disputes, lack of skilled human resources, deficient research and development, and policy inconsistencies and implementation paralysis

Taming high inflation

Monetary policies less effective Rectify market distortions Ban syndicates and anti-competitive practices Check inflationary expectations Boost agriculture production Effectively address structural bottlenecks

Management of migration and remittances

Wider literacy on pros and cons of overseas migration for work Skills development Reduction in transaction/transfer costs Attractive foreign employment bond Easing cost of doing business, especially for SMEs Financial literacy Innovative loan products to migrants and remittance-receiving households
17

2014-04-01

Selected economic indicators (%) 2014 GDP growth Inflation 4.5 10.0

2015 4.7 9.5

Current account balance (share of GDP)

3.6

3.7

THANK YOU!

2014-04-01
18