Key Trends - Nepal 2023

Nepal is taking the lead in implementing its vision for a sustainable, resilient, and inclusive development, steering the nation's long-term economic recovery. Enhancing external competitiveness plays a pivotal role in driving this recovery and positioning Nepal to compete effectively in export markets, addressing both price and quality considerations. Achieving this goal involves prioritizing reforms aimed at boosting domestic productivity and narrowing the inflation gap with Nepal's trading partners. Below are some key insights of factors shaping Nepal in 2023:

1. The estimated Real GDP growth for FY23 declined to 1.9 percent, marking the lowest rate since FY20 and significantly below the 10-year average. Factors such as monetary tightening and import restrictions contributed to this slowdown. Economic activity was particularly subdued in the industry and services sectors, while the agricultural output remained more resilient.

2. The growth in the energy sector prevented an industrial contraction, although manufacturing and construction outputs contracted. Hydroelectric generation increased for the second consecutive year, contributing around 500 megawatts to the national grid. Despite this, Nepal remains a net energy importer.

3. Private investment saw a reduction due to slow credit growth and import restrictions, resulting in lower capital expenditure and public investment. Total investment decreased by more than 10 percent, a sharper decline than in FY20. However, private consumption remained robust, driven by strong remittance inflows.

4. Inflation increased for the third consecutive year in FY23, driven by rising food prices due to supply-side shocks and domestic policy changes. Non-food prices were influenced by higher housing and utility costs. High inflation hinders an effective policy mix to stimulate growth while addressing external imbalances.

5. Domestic policies and trade restrictions by India led to a significant reduction in goods imports, while remittance inflows increased. Exports stagnated below pre-pandemic levels, partly due to real appreciation caused by Nepal's persistently high inflation. Despite this, the current account deficit decreased significantly, and foreign currency reserves increased.

6. The central bank raised its policy rate in early FY23, slowing credit growth to the private sector. Fiscal revenues sharply declined due to a contraction in imports, leading to a doubling of the fiscal deficit to 6.1 percent of GDP, the highest in over two decades. Public debt increased to 41.3 percent of GDP.

7. Growth is expected to rebound to 3.9 percent in FY24 and 5 percent in FY25. The lifting of import restrictions and gradual monetary policy loosening will support this recovery. Hydroelectric production and the service sector are anticipated to drive industrial growth, while agricultural sector growth may slow due to factors such as lumpy skin disease. Inflation is expected to remain elevated, impacting real disposable incomes and private consumption.

8. Looser monetary policy and the lifting of import restrictions are likely to increase goods imports, and a significant remittance inflow is expected. However, the current account deficit is projected to widen to 3.7 percent of GDP in FY24 and 4.6 percent in FY25.

9. Revenues are expected to increase with higher goods imports, but the FY24 budget envisions lower federal spending on capital investment. The recovery of revenues is anticipated to reduce the fiscal deficit to 3.5 percent in FY24 and 3.3 percent in FY25, helping to contain the overall public debt burden at around 41 percent of GDP.

10. High inflation expectations pose a challenge, requiring a careful balance of policies to stimulate growth while addressing external imbalances. External factors such as lumpy skin disease and an erratic monsoon could impact agricultural output, and industry and services may be affected by higher import prices or export bans from India. The recent rise in debt servicing costs underscores the importance of containing the fiscal deficit and ensuring fiscal space for long-term investments.