Nepal: Moderate Growth Expected In 2022/23 Amid Global Turmoil

Economy Signals Recovery, Global Headwinds Persist
Nepal’s economy expanded at 5.8% in 2021/22 after growing at 4.3% in the previous year. Growth was supported by a rebound in the industrial as well as services sector. The industrial sector grew by 10.2% compared with 4.5% in the previous year. The services sector, which has a share of more than 50% of the overall GDP, expanded by 5.9% in 2021/22. Agriculture sector grew at a relatively muted pace of 2.3% due to production disruptions owing to the unseasonal rains in October last year and the shortage of fertilisers.

As the economy was recovering slowly from the Covid-19-related shocks, a new challenge caused by the Russia-Ukraine conflict emerged. Considering the indirect impact of the war on the economy, international organisations have lowered the country’s growth outlook for the next financial year. The Asian Development Bank (ADB) has projected the economy to grow at 4.7% in 2022/23, down from the previously estimated 5%, citing high inflation, slowing trade and monetary tightening. The World Bank has projected Nepal’s economy to grow at 5.1% in 2022/23 supported by a rebound in its tourism sector and strong industrial growth.

As per the budget for 2022/23, the government has set a much-higher target of 8% growth for the current financial year aided by improved private sector investment.  However, the rising borrowing costs could dampen investors’ confidence and could curtail private sectors’ investment. With the reopening of the economy, tourism has bounced back but remains below the pre-pandemic level. The contribution of tourism sector to Nepal’s GDP is significant, hence the revival is critical to attaining the targeted growth. Additionally, challenges on inflation and foreign exchange reserves front persist.

Monthly Data 

Food Prices Push Inflation Upward 

Retail inflation surged to a six-year high of 8.6% in the month ended mid-September compared with 3.5% a year  earlier driven by high prices of food and fuel. This was the fourth consecutive month in which retail inflation has  remained above 8%. While non-food and service inflation remained elevated near 9%, food inflation jumped to  8.2% from 7.1% in the previous month. The main contributors to the food inflation were cereals and vegetables.

Going ahead, Nepal’s retail inflation is likely to moderate helped by the rising base, tighter monetary policy and lower oil prices. However, increased public spending ahead of the elections scheduled in November 2022 could add to the inflationary woes. According to ADB’s projection, retail inflation in Nepal will likely marginally decline to 6.1% in 2022/23 from 6.3% in the last financial year.

Wholesale inflation also jumped to 14% in the month ended mid-September from 12.6% in the previous month led by high food, fuel and power prices. The wholesale inflation has remained in double digits for the past eight months. In the coming months, easing of basic metals prices, oil prices and good agricultural harvest could offer some respite.

To tackle high inflation and to restrict credit growth, Nepal Rashtra Bank resorted to a tight monetary policy by raising its policy rates by 150 basis points in July 2022.

External Balance Improves; Weaker Currency Remains a Concern
Nepal’s Merchandise exports declined 40.4% to Rs 13.9 billion in the month to mid-September, as against an increase of 115% in the same period of the previous year. For the same period, merchandise imports decreased 13.1% to Rs 142.3 billion against an increase of 76% a year ago. The total trade deficit decreased by 8.6% to Rs 128.4 billion in the month to mid-September compared with an increase of 71% in the corresponding period of the previous year. The decline in trade deficit is supported by the easing of commodity prices which could provide some relief to Nepal’s dwindling foreign exchange reserves. Nepal is heavily dependent on imports of items like petroleum, edible oils and machinery products. The prices of these items have been on a declining trend in the international market which could have helped in lowering the import bill. Further, imports have also slowed compared to last year as the government has  prohibited the import of certain luxury goods to arrest the decline in foreign exchange.

The narrowing of the trade deficit as well as an increase in remittance inflows has also resulted in an improved Balance of Payments. However, a weaker Nepalese rupee continues to pose threat to the country’s external balance, inflation and foreign debt. Global uncertainties on account of the Russia-Ukraine war have led to the strengthening
of the US dollar. As a consequence, the Nepalese rupee against the US dollar has depreciated by nearly 8% in the past year.

Nepal’s gross foreign exchange reserves fell nearly 16% (y-o-y) to USD 9.35 billion in the month that ended mid-September. The current level is  sufficient to cover imports of goods and services for 7.7 months against Nepal’s target of maintaining the import cover of at least seven months.

Interest Rates Continue to March Upward
Following the increase in policy rates by the Central Bank in July, the lending and deposit rates have also inched upwards. Higher lending rates are expected to restrict credit growth while higher deposit rates will attract deposits amid the ongoing liquidity crisis. While higher borrowing costs could help lower inflation, it could adversely impact private sector investments by raising their cost of production.

The weighted average lending rate shot up to 12.06% in the review period from 8.57% a year ago. During the same period, the weighted average deposit rate has gone up by more than two percentage points to 7.81% in the month ended mid-September 2022.