AT A GLANCE

In 2018, the World Bank came up with its Country Partnership Framework (CPF) covering the five-year period of FY2019-2023. Coincidentally, this came at a time of historic transformation in Nepal, as a new government took up office in February 2018. The signing of the Comprehensive Peace Agreement in 2006 ended a 10-year conflict that came at a significant cost of lives and foregone economic development. Since then, Nepal has gone through lengthy and complex transitions towards a new Constitution in 2015 that set in place a federal structure. By the end of 2017, elections were successfully held at the federal, state, and local tiers. There is a newfound optimism for greater political stability, inclusion, good governance and sustainable growth. The new federal structure presents unprecedented opportunities for Nepal to reset its development storyline, as outlined in the Systematic Country Diagnostic (SCD). At the same time, the shift to federalism poses new challenges and source of fragility, given the heightened popular aspirations and expectations. Key challenges include the need to clarify the functions and accountabilities of the federal, state, and local governments; deliver basic services and maintain infrastructure development; create a conducive environment for the private sector; and address governance weaknesses that may worsen in the early years of the new federal system.

COUNTRY CONTEXT

A new government, backed by a historic majority in Parliament, completed a year of office on February 15, 2019. The government was preceded by elections for all three tiers (local, state and federal) of the state architecture defined by the new constitution, marking a protracted but successful conclusion of a political transition that began with the signing of the Comprehensive Peace Agreement in November 2006. State governments largely mirror the coalition at the center. At the sub-national level, funds, functions and functionaries hitherto managed by the central, district and village authorities are moving to the seven new states and 753 local governments for which new legislation, institutions and administrative procedures are being formalized as constitutionally prescribed. Meanwhile, the central level authority is being streamlined with a focus on oversight. These exercises at state restructuring are expected to result in improved outreach and service delivery but will likely take time before they become fully operational.

Significant adjustments need to be made to the government structure. They include amending over 400 existing acts, restructuring the civil service at all levels, devolving fiscal management, and determining the division of funds, functions, and functionaries between various levels of government.

In contrast to the frequent changes in government that characterized Nepal’s decade-long transition to federalism, the new government enjoys a historic super-majority in Parliament. Along with new constitutional checks and a far fewer number of political parties, there is a much greater degree of optimism for stability in the coming days. However, state restructuring on this scale is uncharted territory for Nepal and smoothening the transition from the previous unitary system to the new federal one will remain a daunting task. The new system, in principle, provides opportunities to decentralize development benefits and make service delivery more effective and accountable. However, the risks of jurisdictional overlap between the three tiers of government, lack of clarity and coherence between policies and devolved powers, and duplication of efforts will remain high during the coming few years. Key aspects of the new system require further definition and may continue to be contested by different population groups.

RECENT ECONOMIC DEVELOPMENTS

Economic growth is expected to fall in Nepal to a range between 1.5 and 2.8 percent in FY2020 reflecting lower remittances, trade and tourism, and broader disruptions caused by the COVID-19 outbreak. A prolonged outbreak of COVID-19 is likely to affect growth significantly with a further deceleration or contraction in services and industrial production. Economic growth during FY2021 is also likely to remain subdued due to the lingering effects of the pandemic with some recovery expected in FY2022.

Weak agricultural activity is expected to have lowered economic growth during July-January FY2020 (first half of FY2020). Delays in the monsoons and crop damage by army worms and fake seeds reduced paddy production by 1.1 percent. Growth in services, particularly, hotels and restaurants, is also likely to have moderated with lower tourist arrivals in the first half of FY20, mainly from India. On the demand side, growth was primarily supported by government consumption (higher wages) and net exports (lower imports).

Average inflation was 6.4 percent in the first half of FY2020, driven by higher vegetable prices and increased import duties on certain agricultural and industrial goods. This widened the inflation gap with India and contributed to a 2.1 percent real effective exchange rate appreciation of the Nepalese Rupee. Credit growth exceeded deposit growth reaching 8.7 percent, leading to reduced loanable funds. But the financial sector remained well-capitalized, with the non-performing loan ratio at 1.8 percent in January 2020.

As the trade deficit contracted because of lower imports, the current account deficit narrowed by 44.3 percent during the first half of FY2020. Imports declined by 3.5 percent, with lower demand for reconstruction-related industrial supplies (iron, steel, and coal) and gold (due to higher prices) and lower petroleum prices. Exports remained low (3.3 percent of GDP in FY2019) but grew by 22.2 percent on the back of higher external demand for refined palm and soybean oil. Meanwhile, remittance inflows grew only by 1.2 percent to $3.9 billion, reflecting reduced net outmigration. Loans and a drawdown of foreign exchange reserves financed the external deficit. As a result, foreign reserves stand at $9.7 billion or 8.4 months of imports as of January 2020.

The budget remained in surplus because of lower execution of capital budget, at 15. 4 percent of the total in the first half of FY2020. Recurrent spending in the first half of FY2020 grew by 3.7 percent, driven by transfers to subnational governments, higher wages, and social security payments. Meanwhile, revenue growth decelerated to 13.3 percent in the first half of FY2020, because of lower import tax proceeds.

The estimated poverty headcount ratio (at the $1.90 per person per day international poverty line) was 15 percent in 2010 in Nepal, which further declined to 8 percent in 2019. At a higher line of $3.20 a day, 39 percent of the population in Nepal is estimated to be poor in 2019, a 15 percentage-point decrease from 2010. About 31.2 percent of the population that are estimated to live between $1.9 and $3.2 a day face significant risks of falling into extreme poverty, primarily because of reduced remittances, foregone earnings of potential migrants, job losses in the informal sector, and rising prices for essential commodities as a result of COVID-19.

Last Updated: Apr 12, 2020