Domestic risks arise from the financial sector, especially cooperatives, according to International Monetary Fund (IMF) staff mission.
The mission led by Alexander Pitt to conduct the Article IV Consultation discussions met with the various actors of the economy – in Kathmandu during April 9-22 visit – has said a largely unsupervised, outside the banking system supervised by the central bank, cooperative sector is growing rapidly. Supervision, despite improvements, needs further strengthening, it said, asking to push forward financial sector reforms. “The Nepal Rastra Bank (NRB) has made progress in addressing financial sector risks. However, the recent assessment under the Financial Sector Assessment Programme found that risks are still significant. Asset quality remains a concern, while connected lending is widespread and the fragmentation of the banking system makes supervision difficult.”
In this context, the NRB should not hesitate to exercise its corrective and sanctioning powers. The legal framework for the financial sector also needs to be upgraded, the mission reported.
Likewise, fiscal policy needs to support growth and poverty reduction through much-needed capital expenditure. Strong revenue growth in recent years, and ongoing efforts to improve revenue administration, are creating the fiscal space for this. Key areas for investment with a large impact on potential growth are power generation and distribution, and upgrading and expansion of the transport network. Investments in these areas would also likely crowd in private sector investment, as they would provide essential infrastructure for agriculture and industry. Broader structural reforms are also needed. Notably, the expansion of telecommunications infrastructure and services, especially financial services through mobile telephony, could transform access to finance.
The mission after intense discussions with finance minister Dr Ram Sharan Mahat, central bank governor Dr Yuba Raj Khatiwada, finance secretary Yuba Raj Bhusal, other senior officials, and private sector representatives and development partners, also concluded that GDP growth slowed to 3.5 per cent in 2012-13, largely due to a weather-related slowdown in agriculture, but the delay in passing a full budget also resulted in low capital spending. “Inflation rose to over 10 per cent year-on-year in December 2013 in the wake of the sudden drop in the value of the Indian rupee, but moderated to 8.9 per cent in March. Remittances have continued to grow rapidly, leading to a balance of payments surplus. Broad money and private sector credit grew at 21.5 per cent and 15.5 per cent, respectively in March.”
Growth is recovering, and inflation is moderating. Output growth is expected to pick up to around 4.5 per cent in 2013-14, driven by a recovery in agriculture, strong services, and rising public spending underpinned by timely budget approval. Inflation is projected to moderate further from recent levels but remain high, at eight per cent (year-on-year). Growth of remittances is expected to moderate, but international reserves should continue to rise.
But key external risks to the outlook stem from a possible slower-than-projected recovery in India, or a slowdown in countries that host Nepali workers, it reported.
On the other hand, decisive reforms to increase public investment would likely strengthen confidence and private investment, raising growth beyond baseline projections.
The mission noted that the level of the exchange rate appears broadly in line with fundamentals, if remittances are taken into account. However, remittances skew domestic activity to non-tradables and contribute to reducing the competitiveness of agriculture and industry. The peg to the Indian rupee serves as a useful and transparent anchor, and continues to benefit Nepal in view of its close economic relationship with India.
Moreover, the depreciation of the Indian rupee has created an opportunity to benefit from enhanced competitiveness vis-à-vis third countries.
“Harnessing the financial sector and remittances to support economic development is difficult. Care must be taken to preserve financial sector soundness, and it needs to be recognised that monetary and macroprudential policies alone cannot compensate for a lack of infrastructure and other structural impediments to growth.”
In this context, the volatility and level of excess liquidity should be reduced, and policies implemented to facilitate monetary management, and to lean against inflation, the IMF suggested.
As always, the IMF has suggested to free up resources for investment and social spending by increasing fuel prices. “Nepal Oil Corporation (NOC) losses need to be addressed to free up resources for investment and social spending,” the mission said, welcoming the recent adjustment of fuel prices.
It also encouraged the authorities to implement further price increases, ideally through an automatic price adjustment mechanism to avoid recurrent losses, which ultimately have to be financed by the government.
The IMF mission reiterated its support to provide intensive support for Nepal’s reform efforts in the areas of banking regulation and supervision, anti-money laundering, and crisis management, as well as for tax administration, and tax policy.