1

Asian Development Outlook (ADO) 2015: NEPAL

Chandan Sapkota

Asian Development Bank

Nepal Resident Mission

ADO launch (press conference), Kathmandu, 24 March 2015

2015-03-24 2

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.

2015-03-24 3

Presentation Outline

FY2014 Economic Performance GDP growth

Inflation

External sector

Fiscal and monetary developments

FY2015 and FY2016 Economic Prospects GDP growth

Inflation

External sector

Developing Financial Sector in Nepal

Policy Challenge: Accelerating Capital Spending

2015-03-24 4

FY2014 Economic Performance

• Growth accelerated to an estimated 5.2%

• Inflation abated but remained high

• Continued budget execution weakness

• External situation strengthened

2015-03-24 5

FY2014 Overview

2015-03-24 6

GDP Growth (Basic Prices)

GDP growth accelerated to

5.2% in FY2014

Favorable monsoon

Agricultural growth at

4.7%

Strong remittance inflows

Services growth at 6.1%

Industrial output sluggish

Binding supply-side

constraints

4.3

3.8

4.6

3.5

5.2

0

2

4

6

2010 2011 2012 2013 2014

Percentage points

Supply-side contributions to growth

Services Industry Agriculture

Note: Years are fiscal years ending on 15 July of that year.

2015-03-24 7

Inflation

Annual average inflation stayed

high at 9.1% in FY2014

• Higher food prices offset gains

from falling prices of non-food

items

• Food inflation averaged 11.6%

despite good agricultural harvest

• Transport costs rose

• Supply-side bottlenecks

persisted

• Food inflation worsened in India

0

5

10

15

20

Aug2010

Feb2011

Aug Feb2012

Aug Feb2013

Aug Feb2014

Aug Jan

% change

Monthly inflation

Overall Food & beverage Nonfood & services

2015-03-24 8

Current Account Balance

Current account surplus expanded

to 4.7% of GDP in FY2014

Export growth 5.1%

Import growth 13.9%

Trade deficit 30.9% of GDP

Worker’s remittance growth

11.9%

28.2% of GDP ($5.5 bn)

BOP surplus surged to $1.3

billion

Forex reserves increased to

$6.9 billion

Covers 10.2 months of

imports of goods and

services

-40

-30

-20

-10

0

10

20

30

40

2010 2011 2012 2013 2014

% of GDP

Current account indictors

Exports Oil imports

Non-oil imports Tourism and travel

Workers' remittances Current account balance

2015-03-24 9

Fiscal and Monetary Developments

Budget deficit: 0.1% of GDP

Actual expenditure: 82.4% of

allocation Budget execution shortfalls

Long-standing procedural and

procurement inefficiencies

Robust revenue mobilization Revenue including grants 21.3% of

GDP

Monetary conditions remained

accommodative

Interbank rate close to zero

Lending and deposit rates declined Real deposit rate negative

Credit to private sector dropped

Monetary policy cannot compensate for

deficiencies caused by structural as well as

supply-side bottlenecks

-10

0

10

20

30

2009 2010 2011 2012 2013 2014 2015

% of GDP

Fiscal indicators

Domestic revenue Grants

Recurrent expenditure Capital expenditure

Fiscal deficit or surplus

BE -10

-5

0

5

10

15

Jul2012 Jan2013 Jul Jan2014 Jul Jan

%

Commercial banks' weighted average rates Nominal deposit rate Real deposit rateNominal lending rate Real lending rateInterbank rate

2015-03-24 10

FY2015 and FY2016 Economic Prospects

Economic outlook is less favorable than in FY2014

Encouraging news from power sector bolstered

business and investor confidence

Substantial moderation of inflation

External position expected to weaken

Downside risk of political instability Unsettled constitutional and governance issues

2015-03-24 11

FY2015 and FY2016 Overview

FY2015: 4.6%

Unfavorable monsoon

Natural disasters (floods

& landslides)

Political uncertainty

(Improved business

confidence and reform-

oriented budget)

FY2016: 5.1%

Normal monsoon

Timely full budget & effective budget execution

High remittance inflows

Normalization of political uncertainties

Strong investor confidence

2015-03-24 12

GDP Growth Outlook for FY2015 and FY2016

FY2015: 7.7%

Expected agricultural shortfall and increase in civil service salaries

Inflation forecast lower than central bank’s target

Sharp drop in international oil prices

Multiple downward revisions to domestic fuel prices

Lower inflation in India

Food inflation to remain relatively high

FY2016: 7.3%

Inflation expected to edge

lower

Better harvest

Broadly stable oil and

commodity prices

Excess liquidity reined in

2015-03-24 13

Inflation Outlook for FY2015 and FY2016

FY2015: 2.7% of GDP

Stable export growth

Lower import growth

Substantially lower oil

import bill

Slowdown in remittance

inflows

Pick up in export growth

Continued lower fuel

prices lowering import bill

growth

Strong remittance inflows

Strong tourism receipts

2015-03-24 14

Current Account Outlook for FY2015 and FY2016

FY2016: 3.5% of GDP

2015-03-24 15

Developing Financial Sector in Nepal

2015-03-24 16

Comparative State of Access to Finance

0

20

40

60

80

100

120

140

160 Outstanding deposits with commercial banks 2011 (% of GDP)

0

20

40

60

80

100

120 Outstanding loans from commercial banks in 2011 (% of GDP)

0

20

40

60

80

100

120 Account at a formal financial institution in 2011 (% age 15+)

South Asia avg

OECD avg

0

10

20

30

40

50

60

70

Bhutan(2009)

Sri Lanka(2011)

Nepal(2013)

Bangldesh(2013)

India(2014)

Pakistan(2007)

PRC(2012)

Percent of firms with a bank loan/line of credit

OECD avg

South Asia avg

Total deposit: 73% of GDP

Total Credit: 68% of GDP

NPL (Share of total loan) declining; 2.9% in mid-July 2014

CAR: 12%

Stock market capitalization: 54.8% of GDP

Fairly stable finance sector compared the time when real estate and housing prices collapsed. Banking sector troubles surfaced prompting proactive role of the central bank

Persistent excess liquidity Lack of investment-ready projects and favorable business environment

Rate of deposit mobilization > Rate of credit outflows

Declining lending and deposit rates

Ongoing consolidation of BFIs

Strengthened regulatory and supervisory capacities

Financial sector vulnerability persists

Bond market development at nascent stage

2015-03-24 17

Status of Finance Sector

Liberal licensing regime led to too many BFIs and unhealthy competition. Faster and effective consolidation is better.

Sound corporate governance

Continuous strengthening of NRB’s monitoring, supervision and regulatory capabilities Cooperatives need to be better supervised and monitored.

Enhancing internal project and loan assessment

Operation efficiency and product/package innovation

Improvement in investment climate

Enhance productive sector lending

Important for an efficient financial sector that helps to generate high, sustainable and inclusive economic growth

2015-03-24 18

Reducing Financial Sector Vulnerability

2015-03-24 19

Policy Challenge: Accelerating Capital Spending

2015-03-24 20

Inadequate and Weak Capital Spending

Persistently weak capital spending Planned and actual spending

far below the required investment in infrastructure

Actual spending < planned spending

• Insufficient capital investment to bridge infrastructure gap

• Spending on land, buildings, furniture & fittings, civil works, vehicles and plant & machinery

0

2

4

6

8

10

2005 2006 2007 2008 2009 2010 2012 2013 2014

% of GDP

Budgeted and actual capital spending

Actual Budgeted

Raising quality and quantity of capital

spending is one of the pressing

challenges

2015-03-24 21

Low Absorption Capacity

71.8 71.6 70.8

82.6

74.9

0

20

40

60

80

100

120

FY2009 FY2010 FY2012 FY2013R FY2014P

Actual spending (% of planned spending)

Recurrent Capital

2015-03-24 22

Bunching of Capital Spending

0.1

0.6

3.1

2.0 2.2

3.5

3.3

4.9

6.6 5.0

8.4

24.1

0

20

40

60

80

100

120

Aug-13 Sep Oct Nov Dec Jan-14 Feb Mar Apr May Jun Jul

Monthly expenditure in FY2014 (NRs billion)

Recurrent Capital Financing

2015-03-24 23

Relatively Low Level of Investment

Fixed investment is

lower than LDC

average

Middle income

countries’ average

GFCF : 29% of GDP

Nepal’s GFCF

averaged 21.2% of

GDP over 2004-2013 Public : 3.8% of GDP

Private: 17.4% of

GDP

2015-03-24 24

Low Provision and Quality of Infrastructure

0

1

2

3

4

5

6

7

8

GC

I 20

14

-20

15

Institu

tion

s

Infr

astr

uctu

re

Ma

cro

eco

nom

ice

nvir

on

me

nt

Health

and

prm

ary

edu

ca

tion

Hig

her

ed

uca

tio

na

nd

tra

inin

g

Goo

ds m

ark

et

effic

ien

cy

Lab

or

ma

rket

effic

ien

cy

Fin

ancia

l m

ark

et

deve

lopm

en

t

Techn

olo

gic

al

rea

din

ess

Ma

rket siz

e

Busin

ess

so

ph

istication

Inn

ovatio

n

Mo

re c

om

pet

itiv

e

2014-2015 Global Competitiveness Index

Maximum Minimum Nepal score

Higher capital investment essential for Generating aggregate demand quickly

Accelerating recovery & establishing more sustainable growth patterns

Encouraging tech innovation

Spurring private-sector investment by increasing returns

Higher quantity: Close infrastructure gap

Higher quality: Productivity-enhancing investment

Initially private investment contingent upon public capital investment

Crucial for boosting aggregate demand

2015-03-24 25

Need for Higher Capital Investment

Bureaucratic hassles

Project approval

Inter and intra ministry coordination

Structural issues

Limited capacity of line ministries (planning & implementation)

Lack of strong pipeline of projects ready for implementation

Legislation hurdles (procurement & processes)

Low project readiness

Detailed design

Land acquisition

Project staff and offices

Procurement plans

Weak contractors’ capacity & construction management

Political instability

Poor quality at entry affects budget allocation efficiency as well

2015-03-24 26

Why is Capital Spending low? - Inefficient Budget Execution

Improve quality at entry

Project readiness assessment

A standard framework needed (request, approval and monitoring)

Better inter and intra ministry coordination

Sector investment plans and human resources strategy

Address structural issues

Enhance planning & implementation capacities of implementing agencies

Project bank: Strong pipeline of key national infrastructure projects

Update relevant legislations to boost quality and quantity of spending

Prudent public finance management

Strengthen monitoring and evaluation

Standard monitoring framework

Incentives for better project performers

2015-03-24 27

What Needs to Be Done?

2015-03-24 28

THANK YOU!

Selected Economic Indicators (%)

FY2015 FY2016

GDP growth 4.6 5.1

Inflation 7.7 7.3

Current account balance (share of GDP) 2.7 3.5