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Sat, December 7, 2024

Nepal’s ECONOMIC Outlook in Current Deceleration

B360
B360 August 15, 2024, 3:22 pm
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Nepal’s economy has undergone a complex trajectory in recent years. While it has displayed resilience, it continues to grapple with structural challenges. 
The Covid 19 pandemic dealt a severe blow to the economy, disrupting supply chains, curtailing tourism, and dampening remittance flows. While the economy has shown signs of recovery, the scars of the pandemic are still evident. Inflationary pressures, exacerbated by the Russia-Ukraine conflict, have eroded purchasing power and stifled consumption.
Nepal’s trajectory towards economic prosperity is fraught with obstacles that demand careful navigation. Climate change, an increasingly pressing global issue, poses a significant threat to the nation’s economy. Its agricultural backbone, the lifeblood of millions, is highly vulnerable to shifting rainfall patterns, rising temperatures, and extreme weather events. Beyond the fields, climate change also imperils Nepal’s burgeoning tourism industry, a key foreign exchange earner.
Geopolitical tensions, a constant in the global arena, can cast a long shadow over Nepal’s economic prospects. Trade disruptions, a common consequence of such tensions, can disrupt supply chains, leading to shortages, price hikes, and decreased economic activity. Moreover, the political climate in neighbouring countries can influence investor sentiment, impacting foreign direct investment, a crucial catalyst for growth.
Debt sustainability is another critical challenge. The increasing debt burden can constrain government spending on vital sectors like education, healthcare, and infrastructure. Furthermore, fluctuations in global interest rates can exacerbate debt servicing costs, diverting scarce resources away from development priorities.
Nepal’s heavy reliance on remittances, while a lifeline for many families, also presents economic vulnerabilities. Economic downturns in remittance-sending countries can lead to a sharp decline in inflows, impacting consumer spending and overall economic growth. Diversifying the economy to reduce this dependence is imperative but challenging.
The skill gap between the education system and the demands of the modern job market is a persistent issue. Producing graduates equipped with the skills necessary for a thriving economy is essential. However, brain drain, the outflow of skilled professionals to countries offering better opportunities, further exacerbates this challenge.
Infrastructure development is a cornerstone of economic growth, but Nepal faces significant hurdles. Insufficient funding, coupled with implementation delays caused by corruption and bureaucratic inefficiency, hinders progress. A robust infrastructure network is vital for attracting investments, enhancing productivity, and improving the lives of citizens.
Political instability is a recurring challenge that undermines investor confidence and hampers policy continuity. Frequent changes in government and economic policies create uncertainty, discouraging both domestic and foreign investments. A stable political environment is essential for fostering long-term economic growth.
Overcoming these challenges requires a comprehensive and strategic approach. Diversifying the economy, investing in human capital, improving governance, and building resilience to climate change are crucial steps. Additionally, Nepal must leverage its unique strengths, such as its natural beauty and hydropower potential, to attract sustainable investments and create jobs.
To get a deeper dive into the current state and the future possibilities of the country’s economy, in this edition of Business 360 we spoke to eminent economists like Rameshwore Khanal, Former Secretary, Ministry of Finance; Neelam Dhungana Timsina; Deputy Governor, Nepal Rastra Bank; Nara Bahadur Thapa, Former Executive Director, Nepal Rastra Bank; and Dikshya Singh, Programme Coordinator, South Asia Watch on Trade, Economics and Environment (SAWTEE).

How do global economic trends affect Nepal’s economic growth prospects?
Nara Bahadur Thapa: Nepal is an open economy, which means that global economic trends always influence our country’s economy in a variety of ways. We are very open to international trends, which influence, not just our economy, but also the way we run our industries. Our industrial sector depends heavily on internationally available raw materials, any escalation in price affecting every industry drastically
Concerning remittance, as most of those who leave the country do so as students or low-skill workers, global trends do not seem to affect it as much.
The foreign aid that Nepal receives has definitely decreased due to the global economic trends. Another thing that has decreased is the Foreign Direct Investment. A few years ago, Nepal used to receive almost 20 billion in foreign direct investment. In the past two years that number has not crossed 7 billion. FDI and foreign aid are factors that play a huge role in the modernisation of Nepal’s economy and infrastructure. Many integral institutions for Nepal were constructed with the help of foreign aid.
One of the most important economic indicators for Nepal is tourism. As the world faces recession, it is inevitable that the expected tourists decrease. While tourists have definitely increased it could have increased so much more.
Neelam Dhungana Timsina: The global economy is expected to remain stable with slightly higher than 3% growth for 2024 and 2025. Global inflation is expected to taper off, but at a slower pace especially in developed countries because of higher service cost and commodity prices. However, energy prices are expected to remain low, though uncertainties loom due to global geo-political tensions. Further, the world trade of goods and services has significantly improved in 2024. The growth rates of China and India, the major trade partners of Nepal, are expected to remain stronger due to their improved private consumption and exports.
Nepal’s key sectors that are highly linked to the global economy are trade, employment abroad and tourism. Around 75% of trade takes place with India and China, which are growing 7% and 5% respectively, showing that global economic shocks are shielded by these countries. On the other side, the geopolitical issues in the Middle East might impact robust remittance growth. Tourism, one of the major drivers of economic activities, is also growing in Nepal as global economic growth remains stable around the world. Finally, the remarkable and sustained growth in India and China show the optimistic prospects for Nepal too, if we can well manage the domestic economic issues and raise private sector confidence.
Rameshore Khanal: Currently Nepal’s economic growth has definitely slowed down. However, the growing sentiment that we are in a huge economic crisis is not true. Our airline industry is thriving, the cost of living is relatively low, inflation was high but has since decreased. Of course, the economy is not growing as much as we can hope for, but it is not too weak. The only aspect that is weak I would say is the federal government’s public funds. Taxes are not being raised enough, current spending is too low and the capital that the federal government has is weak. Due to the government not investing enough capital the economy has fallen behind. We are in a strange situation at the moment. Yes, various factors have caused different problems in the past but it is not feasible or responsible to assume that the same will happen in the future as well. It is not suitable for me to say that the economy is in grave trouble. There are some problems but it is not as grave as many are making it out to be.
The main trouble is getting investors as no one really wants to invest. This is happening for two main reasons. The environment around investing is weak. The government’s weak capital spending has not been able to create an environment of investment. Next, the losses faced by the private sector during the Covid-19 pandemic, to a certain degree where a lot of funds had been misused, causes investors who lost money then to be more apprehensive towards investing again. This lack of investing has definitely slowed economic growth in many industries. Industries related to production and construction have suffered a lot. Other industries, however, have made decent growth. Tourism and farming are among those who have bounced back despite everything.

How will Nepal’s transition from least developed nation to a developing nation affect access to concessional loans, trade preferences, or other benefits?
Dikshya Singh: Nepal’s graduation from an LDC to a developing country is a major milestone for Nepal. As an LDC, Nepal has been receiving certain international support measures in the forms of preferential market access, greater development support, and other special treatment. The graduation in 2026 means Nepal might lose some of these support measures. After the transition period is over, Nepal will still avail certain support measures as a developing country but there is a possibility that Nepali products might not be eligible for duty-free-quota-free access to the markets such as the EU, UK and some non-EU countries like Switzerland and Turkey under their Generalised System of Preference Programme. Modelling exercises have shown that post-graduation tariff increases could have a significant impact on Nepal’s top exports unless Nepal qualifies for GSP+. More efforts need to be invested by the government in getting Nepal eligible for GSP+ before the transition period is over. In addition, firms that are exporting their goods under GSP need to be vigilant about the possible loss of preference and the impact on their exports and plan ahead accordingly. After graduation, Nepali products are highly likely to face stringent rules of origin — requiring significant value addition domestically, which could pose significant challenges.
As for development cooperation, Nepal may not face significant impact since concessional loan rates charged by our major development partners, the ADB and the World Bank, are primarily tied to the GNI per capita classification and other criteria of creditworthiness. Still there might be some impact in terms of the grace period for repayment. In terms of bilateral aid, countries like Japan and South Korea consider LDC status for lending, but, in general, the impact on development cooperation, including the terms and conditions of the concessional loans, is expected to be modest.
A significant impact of LDC graduation but not much talked about is Nepal losing flexibility in the implementation of World Trade Organisation rules related to subsidies (Nepal may have to review export cash incentives too), protection to domestic industry, flexibilities with regard to intellectual property regulations, among others. More discourse is necessary to assess the potential impacts on different sectors and their distributional impacts and inform the stakeholders, most importantly the private sector. Similarly, more concerted effort from the government side to generate more bilateral and multilateral engagement to receive similar preferences for Nepal is necessary.
Nara Bahadur Thapa: 1971 was when the categorisation for LDCs was created. Since then Nepal has remained as a LDC for more than 50 years, indicating that for half a century Nepal has not developed relative to other nations. If Nepal is to graduate from an LDC in 2026, it will be the only country to not meet the income criteria and still become a developing nation. It is a very risky proposition with a huge question mark regarding if this is beneficial to Nepal. No one is going to go against the LDC graduation because it is a good indicator of economic growth and a matter of national pride. This does create a dangerous situation where Nepal may lose access to a lot of foreign aid it was receiving on the basis of being a LDC. Studies have shown that concessions in trade and export in the European countries, Turkey and China and others may decrease by at least 5 million dollars. Grants from the World Bank and other similar organisations may similarly disappear. As an LDC we currently do not take loans but rather beg for aid. This is not something we can do as a developing nation. There is also a sentiment that Nepal is a corrupt nation that does not utilise aid properly. As a developing nation, it would be incumbent on us to take loans from institutions like the World Bank and pay it back by working. Is Nepal ready for that? The loss of foreign aid will not affect any politician or rich person, but the poor will end up suffering. With foreign aid being restricted, the first things that will be affected are healthcare and education for the poor. To thrive as a developing nation, Nepali people have to work extremely hard and be competitive. Investments also have to increase both from the private and public sectors. In conclusion, LDC graduation is a challenge for Nepal, and whether Nepal can put in the concerted effort to surmount that challenge remains to be seen. There is also the risk of relapsing to a Least Developed Nation if Nepal does not plan properly.
Neelam Dhungana Timsina: The transition from an LDC to a developing nation can both bring challenges and potential benefits to Nepal.  Regarding the access to concessional loans, it also depends on whether the aid is bilateral or multilateral. Some studies have shown that bilateral aid may not be affected much as it depends on a more strategic geo-political situation. Obviously, the aid disbursement crucially depends on the government’s budget execution and especially the realisation of expenditure plans. On the other hand, we observe that multilateral donors like the World Bank, ADB and UN agencies base per capita income as a major criterion for concessional aid allocation, which can be significantly higher than the graduation threshold.  From this perspective, graduation may have minimal impact on their loans. However, the other multilateral and bilateral donors may consider graduation status for determining interest rate, potentially impacting the loan service costs. 

 

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Banks have been giving a large amount of loans to specific individuals and families. These are not given as a personal transaction but through the organisations they represent, but there is generally only one person or family who holds the majority stake in such organisations. I would say around 20% of these people have been availing around 80% of the loans in Nepal. This is not good for any country.

Rameshwore Khanal
Former Secretary
Ministry of Finance

Regarding the impact on trade preferences, the graduation might mean loss of preferential regimes accorded to LDCs, higher tariffs and more stringent rules of origin (ROO). However, as shown by few studies, the potential loss emanating from these provisions might be low. 
More than 75% of Nepal’s trade is concentrated on India and China, with exports significantly smaller than import. Historically, Nepal has not experienced significant benefit from multilateral trade preferences, thus, bilateral arrangements could be a strategic direction for gain after graduation. 
However, the negative impact could be significant on export industries which are already working on a small scale with high cost. These industries should be protected through other benefits from the government. Nepal’s graduation requires strategic planning, effective implementation, commitment to policy stability and good governance to ensure a conducive investment climate to boost exports.
Rameshore Khanal: The amount of foreign aid that we receive from the international community is not that large. In the last ten years the amount of taxes collected has expanded a lot. The reason that taxes are not enough is because the government has increased the recurrent expenditure too much. But the notion that we cannot develop without foreign aid or the government cannot function without foreign aid is not the situation we are in. The total absence of foreign aid will also not affect us too much.
Speaking on foreign debt, until or after 2026, as long as we are an LDC we should receive the corresponding loans. But as the nation’s income increases, the debt we have from international multilateral agencies will have a corresponding interest rate. In times where the nation feels that we can build something that will have an eventual profit, and a lot of capital is required, we could be brave and take loans from these international organisations. We should not grow too dependent on low interest rate loans and foreign aid, and expect that we will always receive them. We should follow the path a developing nation takes by improving the nation’s psychology. One type of aid we can always expect to receive is humanitarian aid during times of trouble caused by natural disasters like earthquakes, droughts and floods.

 

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For skilled and educated individuals in developed countries, Nepal could explore policies that allow them to work and earn in Nepal, potentially contributing to the economy and sharing their expertise. Additionally, efforts to attract foreign direct investment from Nepali diaspora and others abroad could further enhance economic growth and development initiatives in the country.

Neelam Dhungana Timsina
Deputy Governor
Nepal Rastra Bank

How effective are the government’s fiscal and monetary policies in addressing inflation and promoting domestic investment?
Nara Bahadur Thapa: As long as a country’s fiscal policy does not focus on job creation, capital formation, human resource development, science and technology, a country will not receive any benefits from its fiscal policy. As we are below the production possibility frontier, our aim should be to pursue the above frontiers. That is not something I see happening, which is why Nepal has not received much benefit from its fiscal and monetary policy.
Neelam Dhungana Timsina: The monetary policy and fiscal policy have both coordinating and independent roles to promote domestic investment in Nepal. In general, fiscal policy is growth focused while monetary policy has the primary role of maintaining internal and external sector stability. 
In the current situation, monetary policy has ample room to support investment and growth due to the build up of foreign exchange reserves, abundant liquidity in the system and low inflation. However, raising business confidence and appetite for investment are key challenges to monetary policy as there is low absorption of credit by the private sector. Nepal’s recent monetary policy has been able to contain inflation below its target and accumulate official reserves to cover more than a year’s imports of goods and services. Under this condition, NRB has ample space for accommodative monetary stance to support economic growth. Thus, it should focus on creating a credible macroeconomic policy environment to support domestic and foreign investment. 
On the other side, tax revenue is just enough to finance recurrent expenditure, imposing constraints on fiscal policy. However, there is still sufficient room to mobilise foreign debt for productive investment. Moreover, fiscal policies aimed at promoting domestic investment have included concessions and tax rebates, but their effective implementation has been elusive.
Rameshore Khanal: Due to the government’s instability in terms of strategy, a lot of investments are facing risks resulting in future investment chances decreasing as well. The policies of the government as a whole are not bad. Some of the policies that were working well were often changed, either through the budget or otherwise, often without prior warning which has created a climate of suspicion and distrust. To attract foreign direct investments or to incite investments inside Nepal itself the government needs to listen to the suggestions made by industrialists from the hydroelectricity, forest and many other sectors and make relevant changes. While we are not really weak as a whole there are many aspects that need to be cleaned up regarding policy.
Another thing is stability is necessary for policies, and they should not change again and again. If someone is taking advantage of something, it is not the government’s role to put them in their place by changing the policies.

 

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If Nepal is to graduate from an LDC in 2026, it will be the only country to not meet the income criteria and still become a developing nation. It is a very risky proposition with a huge question mark regarding if this is beneficial to Nepal.

Nara Bahadur Thapa
Former Executive Director, Nepal Rastra Bank

How does political instability in Nepal manifest in terms of implementation of policies, economic uncertainty, and investor confidence?
Nara Bahadur Thapa: While it has its role, political instability is not the only factor that is a detriment to our economy. We had observed political stability during the Rana period, but we did not observe proportional development. Similarly, we were stable during the Panchayat period, which also did not see proportional development, especially in comparison with our neighbouring countries.
Constant political change rarely affects the economy if a country has a strong macroeconomic framework and a functionable monetary policy framework. This is why institutions and frameworks are very important in addition to political stability. Central Banks, Insurance Authorities, Securities Board of Nepal, all need to be independent and strong. If institutions for industries like civil aviation, hotels and restaurants are created that can take care of various aspects of the industry and help regulate business in their own fields, a constant change in the government would not make a difference to their regular functioning. Since such institutions rarely exist, political instability makes a bigger difference. Countries with strong institutions and frameworks are not affected by political instability. While we made our constitution, we were unable to make strong economic frameworks or strong economic institutions either, which is why I believe the government has not been able to deliver and we have fallen behind economically.
Recently the fourth investment summit was conducted. There was one held in the 90’s as well, other than the recent ones in 2017, 2019 and 2023. The one conducted in the 90’s was extremely successful as they brought in Unilever and Dabur among others. One of the main reasons for FDI not being as successful in Nepal as in other countries is due to the existence of outdated bureaucracy that makes it necessary to get various licences and generally go through an unnecessary complicated procedure that deters the already sparse foreign investment. This regime of licences and prior approval needed to be updated before the investment summits. A good example of what to do is India. If we had a better framework, political instability would not really affect us. There is not enough effort to bring the system online, and even if it were successfully implemented, the process is so frustratingly complicated that it is a legitimate reason that deters businesses.
Neelam Dhungana Timsina: It is evident from the low level of foreign direct investments in Nepal that political instability has manifested in low investor confidence. However, besides political instability, other factors also play crucial roles for investor confidence such as infrastructures, financial development, level of digitisation, market size, skill of human resources, etc. Based on our experience, we can surmise that political instability has affected implementation of policies and has increased economic uncertainty. It is obvious that political parties have their own set of agenda and programmes according to political ideologies they follow. But implementation of policies related to economic development can be enhanced if all political parties come together to form a common minimum understanding on economic prosperity and development on the basis of the constitution of Nepal. Stable government can support formulation and implementation of policies by reducing economic uncertainty and enhancing investor confidence.
Political instability might contribute to the cost of doing business in several ways. It might affect starting a business, dealing with construction permits from soil tests to completion certificates, getting electricity, registering property, trading across borders, employing workers etc. However, longer term development plans, strategy papers, policies, and implementation of such plans and policies by bureaucracy, the stable government, can also help build investors’ confidence. Furthermore, investors might also consider the global business environment viz., pandemics, supply chain disruptions, Russia-Ukraine War, Israel-Gaza War, etc. for exploring business opportunities farther from home. Nevertheless, with amendments having been made to major foreign investment related laws before the Investment Summit, Nepal is expected to attract more investments in the coming days.
Rameshore Khanal: Political instability is not an issue for the economy on its own. Other countries also have governments in flux all the time. Some countries are similar to us in that there are the same few parties who come in and out of power, but they are not known for political instability. In Nepal as soon as the government changes the institutional leadership changes. All the ministries have different leadership, including regulatory and implementing institutions. This constant change in leadership in public institutions results in important tasks remaining incomplete. We call this institutional instability. Instead of political instability, I would say that institutional instability is a more damning problem. The changes of political parties causing institutional changes causes the work these institutions do to remain incomplete. This causes a lot of problems for industrialists and regular citizens. The international community also brings up this institutional instability as a reason for the lack of foreign direct investment.

What is the optimal level of foreign borrowing for Nepal, considering its current debt-to-GDP ratio and long-term economic goals?
Dikshya Singh: First, when we talk about public debt or expenditure, it needs to be understood that household (or individual) finance and public finance are not the same. Fiscal deficit is not always bad, it is an important tool to stimulate the economy. The term per capita debt has no economic significance at all. There is no universally acknowledged threshold for the debt to GDP ratio that is considered safe or reasonable as the ‘safe level’ is subjective to the situation of the country. Nepal’s debt to GDP ratio at about 43% is neither big nor unsustainable but the rapid growth rate in the last few years and the reason behind that expansion is definitely a bit alarming. The size of the debt itself is not a concern but whether the borrowed amount is being spent on productive activities is what matters. At present, the government is borrowing to meet the recurrent expenditure needs not solely to finance capital expenditure, which is definitely worrisome.
Moreover, most of the narrative when it comes to public debt is dominated by fear of Nepal being under the debt-trap of some foreign country or multilateral agencies. The external borrowing of Nepal is being done at concessional terms with low interest rate and longer payback terms. The rise of domestic borrowing should be more concerning as higher domestic debt tends to increase real interest rates and have wider implications on the economy beyond public finance.
Neelam Dhungana Timsina: There is no single, universally accepted optimal level of foreign borrowing. The optimal level of debt differs from country to country depending on various factors such as foreign exchange reserves, export situation, remittance, inflation along with economic growth and political stability. As for Nepal, maintaining a debt to GDP ratio of 45% is generally regarded as manageable and sustainable. In FY 2023/24, the debt to GDP ratio is 42.38% (foreign debt 21.68% of GDP) which is moderate compared to many other countries. However, the rapid growth of debt in recent years, especially of domestic debt has increased the debt servicing costs and put a strain on the budget.  
It is thus important to encourage domestic savings and channel the foreign loans towards productive investments in Nepal. Nepal has a lower domestic savings rate compared to its neighbouring South Asian countries. Domestic savings as a percentage of GDP in Nepal is approximately 7.4%, whereas it is 21.4% in Bhutan, 25.6% in Bangladesh, and 29.2% in India. This disparity might seem alarming, but it’s important to note that many Nepali citizens work abroad, and their income isn’t reflected in these figures. However, a significant portion of income is typically spent on consumption, and there’s a tendency towards conspicuous consumption. Moreover, Nepal’s high imports compared to exports indicate that much of the consumption leaks into the foreign economy.
To redirect domestic savings into productive investments, Nepal must overcome several structural barriers. There is a notable lack of entrepreneurial capacity among Nepali citizens, coupled with an absence of a conducive environment to foster such activities. Additionally, financial sector development and inclusion, promoting financial literacy and various fiscal incentives and policy stability could create a favourable investment climate. 
Nepal may not face significant debt issues in the mid-term if it consistently achieves its targeted economic growth, investing in human capital and infrastructure raising the productive capacity of the economy. To sustain a high debt-to-GDP ratio effectively, Nepal must prioritise prudent fiscal management by eliminating wasteful expenditures and enhancing revenue administration efficiency. These measures are crucial for managing debt sustainability.
Rameshore Khanal: The debt per capita does not have any importance. What we need to compare is the revenue that that country generates to the debt accrued. If the debt is more than the annual GDP then we need to be worried. Our debt to GDP ratio at the moment is around 44%. This is very good compared to other nations in the South Asian region. So, to understand the ratio we need to know the taxes levied throughout the year and especially our foreign reserves as that are what we would have to use to pay back our debts. Considering these factors, we are known as a debt solvent country, or a country which is capable of paying back their dues. Legally we have mandated that the debt to GDP ratio should not cross 33% according to the Public Debt Management Act. So, we should not be in much of a desperate situation. In a situation where we may need to spend beyond our means, due to a disaster or a pandemic, we are in a position where we can avail some more loans.

How does Nepal’s position of having to balance relations with India and China affect the economy of the country?
Nara Bahadur Thapa: If the incident at Galwan had not taken place, Nepal would be in a much better place economically. The skirmishes between the countries have led to the relationship between the countries souring immensely. This does not really affect either country too much, but the effect on Nepal is tremendous. Companies like Huaxin Cement came to Nepal in lieu of the 2017 Investment Summit before the Galwan incident, which has resulted in Nepal becoming self-reliant in the cement industry. If we had been able to get Chinese funding for Nepal’s hydroelectricity plans, we would have been self-reliant in four months. China is one of the world’s biggest economies, to the point that they are desperate to invest. India is growing but has not reached the level of China just yet. We should, however, learn from how the current Indian government is dealing with Russia and the USA and keeping them both equidistant. A better example would be how Bangladesh deals with both India and China. Nepal needs to create a climate where both our neighbours want to invest in our development.
Neelam Dhungana Timsina: The open and transparent relations of Nepal with India and China could avoid doubts of both neighbours. For this, we could focus on economic relations, especially on trade, tourism and investment. The non-discriminatory policies towards businesspeople and investors of both neighbours should be ensured to enhance trade and investment as well as trust and credibility of the country. China is the world’s second-largest economy, and India is one of the fastest growing emerging market economies being the fifth-largest one. Nepal is a relatively small economy compared to both India and China. Being neighbours, India and China can offer distinct advantages to Nepal from trade and investment and potential transit routes.  Recently, Nepal’s tourism sector has also become increasingly dependent on these neighbouring nations. Therefore, I see numerous economic opportunities for Nepal. The key lies in effectively harnessing the opportunities of neighbours for economic and social benefit.
Rameshore Khanal: If we are able to properly navigate this situation, we have the two biggest markets in the world as our neighbours. If we were to produce enough and start exporting then we have access to two population demographics, each in the billions. On the other hand, if we are unable to satisfy their security and other concerns then our desires of development may not be realised. An example could be the Lumbini airport or the Pokhara airport. Due to political problems, they cannot work to their full limit. India is concerned about giving a Chinese funded airport access to airspace. Some industries that had the opportunity to be set up in the Terai with Chinese funding have been met with objections from India. Our dreams for development have to go alongside cooperating with India and China. There are opportunities for profit as well as detriments.

How can citizens be part of the conversation about fostering new industries and job opportunities to reduce loan burden and remittance dependence?
Nara Bahadur Thapa: In countries like India, if there is a new discovery it is immediately added to the syllabus. A lot of colleges have discussions based on the topic. There are always conversations going on around the country. Information regarding matters of national importance is disseminated throughout the country through a variety of channels so that the citizens are always intimately aware of economic policies, industry policies, etc. The mediums through which such matters are brought to the ground are through schools, colleges and the media. This happens in Nepal as well, but not to the degree it should. Citizens in Nepal are not as aware as many other democracies. Voting is not the only thing we should be beholden to. We have not reached a stage where we vote based on what the political parties are going to do if they win.
Neelam Dhungana Timsina: Nepal faces challenges with entrepreneurship and managerial skills due to brain drain. A proportion of skilled individuals have migrated to developed countries, while another segment of the youth population has moved abroad for low-skilled jobs in Gulf countries. To foster new industries and job opportunities, Nepal needs a nurturing and enabling conducive investment climate to create meaningful jobs for the youths. Creating such an environment is a gradual process that requires concerted efforts to develop local talent, improve education and skills training, and create attractive opportunities for skilled individuals to stay or return to Nepal. Addressing these challenges is crucial for sustainable economic growth and reducing the impact of brain drain on the country’s development prospects.
Nepal can initiate by organising its agricultural sector, investing in necessary infrastructure, and promoting agro-based industries that process agricultural products. This approach aims to retain low-skilled workers who might otherwise migrate.
For skilled and educated individuals in developed countries, Nepal could explore policies that allow them to work and earn in Nepal, potentially contributing to the economy and sharing their expertise. Additionally, efforts to attract foreign direct investment from Nepali diaspora and others abroad could further enhance economic growth and development initiatives in the country. These strategies could help mitigate the effects of brain drain and leverage the skills and resources of Nepali individuals both domestically and internationally.
Rameshore Khanal: The leadership for this is something that the government needs to take. The citizens or industrialists cannot create a government-business compact with much effectiveness as they are not one singular body. The government has tried to create such forums from time to time. The investment summit was one such medium of discourse. There were both foreign and domestic investors present.
Since the government is so prone to change there is no stability to creating a compact with the national level. Citizens should be close to their municipal governments. A compact is more possible at this level. The reason such forums for dialogue don’t exist is because of the political instability and the parties not having a set agenda.
The coalition governments are not strong enough to establish these avenues for dialogue between citizens, businesspeople and the government which is very important for the development of the nation. Each of these actors are necessary. Collaboration between the public and private sectors is necessary for large projects like building dams as the private sector can bring the necessary capital and expertise. This is not happening due to mutual distrust between the private sector and the government, as they both expect the other to try and keep all the profits for themselves.

 

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Nepal’s debt to GDP ratio at about 43% is neither big nor unsustainable but the rapid growth rate in the last few years and the reason behind that expansion is definitely a bit alarming. The size of the debt itself is not a concern but whether the borrowed amount is being spent on productive activities is what matters. 

Dikshya Singh
Programme Coordinator, South Asia Watch on Trade, Economics and Environment (SAWTEE)

Does foreign investment offer opportunities for skill development, career advancement, and competitive wages?

Dikshya Singh: FDI could be an important tool propelling much needed structural transformation in Nepal that would shift resources to sectors with high productivity and ability to create mass employment. FDI in the manufacturing and services sector would definitely expand the existing employment opportunities. Firms with FDI are more professionally managed, use better technology, and are highly likely to be integrated with the global value chain. So, these firms not only bring in capital but also other advantages such as technology transfer and market access. Relationship between FDI and wages is a bit complex as in some countries FDI has lowered wages in the sectors and regions where bargaining power of labour is low. Impact of FDI on wages varies depending on the sectors and the skill levels of the labourers. Understanding these dynamics is crucial for policymakers aiming to maximise the benefits of FDI while mitigating its potential downsides.
Nara Bahadur Thapa: The most important path to resolve this is through education. The government needs to continuously invest in education and human resource development. While the top-level positions of many institutions may be held by foreigners, it is also a positive thing. They also give us the opportunity to learn from them. There should not be any push towards not having foreigners, as they bring a lot of positives as well.
Neelam Dhungana Timsina: Foreign investments can create both high and low-wage jobs, directly or indirectly. Foreign establishments in Nepal do also offer various opportunities for skill development, career advancement and competitive wages. With a view to have transfer of advanced technology in Nepal that can translate to skill development, career advancement, competitive wages and a pathway from decent-paying jobs to advancement for Nepal workers, Nepal has been open in attracting technology transfers along with foreign investments since September 30, 1981 with enactment of Foreign Investment and Technology Related Act, 2038 BS, later replaced by Act of 2049 BS and now effective Act, 2075 BS. Moreover, the Act has the provision to give employment priority first to Nepalese citizens and only if a suitable Nepali candidate is not available, foreigners can be employed.
Rameshore Khanal: In terms of cost itself, if a person of a similar skill level is available in Nepal, a foreign company will not bring a more expensive worker from abroad all the way to Nepal. The most important thing is skill. If the skill is not available, it is not enough that people are here. If a qualified person is available then there is no reason to bring in someone from abroad. The biggest example is the banking sector. In the past even mid-level employees were brought in from abroad. Nowadays, even the top level is made up of Nepali people. Similarly in the IT industry. Forcing unskilled Nepali to work somewhere will hamper a company’s growth. These foreign companies also create a lot of tertiary jobs and ancillary businesses. It is important to consider if these companies have created an ecosystem of jobs.

How would you rate us on preparedness on the potential impact of Artificial Intelligence on specific industries in Nepal?
Nara Bahadur Thapa: Nepal’s preparedness is not good. I say this because technology is imported through institutions and not individuals. I would attribute India’s massive growth to the establishment of good institutions in the past, whether it be universities or research institutions. It is through these institutions that citizens get the opportunity for skill development. These institutions were not established in Nepal, and the sparse few that exist have been weakened due to it being politicised. There is politics in India as well, but not at the level of learning, either in school or colleges. In Nepal, there is politicisation from NGOs to Cooperatives to Schools. For development in skill and technology, institutions are required. If cooperatives were strong then there would be great development in farming. The research centres in places like Khumaltar and Lumle exist but are not as effective as they could be.
Concerning AI, it will look like it is taking away jobs for the beginning but eventually, it will end up creating more jobs. I also believe that it will free us from many menial jobs that are still dependent on humans. That is why I believe the apprehension people have for the technology is only temporary. I believe it will play a huge role in reforming the systems of governance and will help raise the standard of living for all humans. We cannot close down hospitals because the Jhakris will lose their jobs.
Neelam Dhungana Timsina: In recent years, Nepal’s IT industry is showing IT competence of Global standard and growing rapidly generating noticeable revenue for the country. As of today, it is well predictable that education, health care and financial sectors will be mostly impacted by AI showing transformational results with AI powered HR, enhanced diagnostic and health care, improved customer service and fraud detection. Government should encourage AI related education and adopt liberal policies to implement AI based initiatives. We are in the initial stage of adoption of AI technology. For example, Banks are using ‘ChatBot’ for customer services.
Rameshore Khanal: At the governmental level there is not much preparation as far as I can see. In the private sector, especially in youth entrepreneurship, it is definitely causing a buzz. But compared to the global scene there is not enough work going on, either in research or development. A lot of foreign countries see governments investing in such technology which is definitely not taking place here. I believe that if the government creates an enabling environment, then the public sector is prepared.

How does the banking sector’s instability affect access to credit for individuals and businesses?
Nara Bahadur Thapa: Banks and financial institutions are financial intermediaries for savers and borrowers. They are simply mediums for capital to move around and accumulate. For the economy to be healthy, for the country to develop, for job creation, the financial health of these intermediaries is important. Currently, the state of these financial intermediaries has reached a point where the state needs to intervene to strengthen them. The reason the country’s economy is stagnating is in some part due to the country not having a vision for what areas these financial intermediaries need to work in, what kinds of policies need to be implemented and what institutions need to be established.
The reason that the government may have to get involved in our open-economy is because our regulators have become weak, both for banks and cooperatives. They should have been working more effectively. The reason that the microfinances, cooperatives and banks are in trouble is because of the regulators not being committed to their work. The banks have not completely drowned yet because Nepal Rastra Bank is still alive. But it is not strong enough to make sure that there is adequate development happening in the banking sector. Recently, with the corruption exposed in certain cooperatives all that ended up happening was some drama, where the most that happened was a report being created which will inevitably remain on a shelf, not bringing any actual solutions. Regulators should also be held accountable for negligence.
Recently we went into the Universal Banking Business Model, which has not been able to deliver as expected. The mergers of many necessary banks have caused many issues as well. There were around 88 development banks, the number has now decreased to 17. This has ruined entrepreneurship. Startups do not require loans in the billions. The institutions that adequately financed startups merged with larger institutions that only deal in the billions, leaving startups with no options to get financing from. These mergers and acquisitions are a lot like having all of your eggs in one basket. The banks had reached a certain point where they were essentially playing Dhukuti. If Rastriya Banijya Bank had not joined the IMF’s programme it would have been in the same position as many of the cooperatives currently. The Rastra bank has to focus on entrepreneurship and the development of the private sector.
To make the financial intermediaries strong, financial auxiliaries like Asset Management Companies are required to repair the balance sheets of banks by liquidating assets so the bank can have capital. Another auxiliary necessary are Business Development Service Providers. There used to be a few but they have closed now. Without BDS’s SMEs don’t generally get financed, Venture Capitals and Startups cannot get financed properly. There should be places to get loans on the basis of movable assets like vehicles. Provisions exist but they need to be more defined. The Credit Information Bureau has provision for this but does not receive much mileage.
Neelam Dhungana Timsina: Nepal Rastra Bank (NRB) is deeply committed to increase the access of financial service and public confidence towards the banking and financial system. These goals are fundamental objectives of NRB outlined in the NRB Act. To maintain financial stability and safeguard public deposits, NRB issues directives to banks and financial institutions which are based on international best practices and norms of banking. The banking sector operates under close supervision and regular monitoring of NRB in accordance with these directives. In the recent scenario, the major indicators of banks such as capital adequacy, CD Ratio, Liquidity, etc are as specified by NRB. This regulatory framework has fostered a climate of trust among the general public regarding the safety of banking services. Over the past eleven months, deposits in financial institutions have grown by 9%, while private sector credit has increased by 5.1%. Year-on-year, deposits have risen by 12.6% and private sector credit by 5.6%. Despite reduced interest rates in financial institutions, the rise in deposits reflects public confidence in the banking sector.
Mergers and acquisitions are viewed as crucial strategies to enhance the efficiency and performance of the financial industry, thereby improving financial indicators. The merger and acquisition bylaws 2073 had the aim of strengthening the financial, human, technical, and overall capabilities of financial institutions to safeguard clients, investors, and stakeholders. Mergers have predominantly contributed to operational growth rather than resulting instability.
Regarding recent issues in cooperatives, the concerned regulatory bodies of cooperatives are actively addressing these challenges and working to restore public trust in the cooperative sector.
Rameshore Khanal: As a whole, saying that the situation with the banking systems is bad is incorrect. Compared to the past it has definitely declined, especially in terms of the property. There is an increase to the amount needed to provision, and a prediction that profits are going to decrease because the quality of the property has decreased. Compared to our neighbouring countries, the situation is not so bad. While it might not have improved to the scale we hoped it would, it has definitely increased. The bank’s property has not decreased, the amount of money in the system has definitely increased.
Cooperatives have definitely suffered due to many oversights. Especially due to the institutions not giving enough care and attention, with many bad investments being made, cooperatives have reached a breaking point, but not to the point where they would endanger banking systems. The government has not done enough to resolve the situation yet but it will take some time. As a whole I would have to say that the banking systems are doing well.
The mergers were prompted because individual banks did not have the capital to sustain themselves. It did however work towards some detriment because well-functioning banks had to merge with subpar banks and take on their mistakes as well, solving which took time and resources away from the innovation they could be achieving. Thus, this has put some doubt on the effectiveness of this policy.

A significant portion of Nepal’s workforce operates in the informal sector. Can this sector be formalised to some extent, creating tax revenue for the government and providing social security benefits for workers? Are there innovative approaches being considered to improve working conditions and provide access to credit for informal businesses?
Dikshya Singh: The narrative that informal is bad and formal is good is not entirely correct. Informal jobs are providing income opportunities to the section of the population that could have been left out of the labour force. In Nepal, almost 85% of the workforce is employed informally and 90% of women in the workforce are informally employed. Even in terms of paying taxes, although informal workers may not pay direct income taxes, they contribute to government coffers while buying any goods and services in the form of indirect taxes, such as VAT, customs, excise etc. Having said that, it is also important to recognise that informal workers lack protection from labour laws and any other forms of social protection afforded to formal workers. Hence, informal workers are more vulnerable to losing jobs and have to work in unsafe and unhealthy working conditions, and work in low-skill, low-paying jobs with irregular working hours. Since it is practically not possible to make all the jobs formal, as there are reasons why workers choose to remain informally employed (that is, daily wage or piece-rate basis), efforts need to be made to improve existing conditions of the workers. Policies that incentivise the businesses to instil a better working environment could help protect the workers too. Provisions to encourage workers to come under the social security coverage, irrespective of the nature of employment would be useful in protecting workers’ welfare.  
Nepal Economic Census reports that almost half of business establishments in Nepal are operating without being registered — meaning informally. A study by the Central Department of Economics, TU estimates the size of the informal economy to be equivalent to 43% of Nepal’s GDP. Informal economy does not stand alone afar from the formal and the lines between formal and informal sectors get blurred as these sectors get integrated at various stages of production networks. Businesses operate informally as the cost associated (real or perceived) with becoming formal is higher compared to the benefits accrued. Remaining informal may accrue some benefits such as not having to pay taxes or fulfil all the compliance requirements but it also means these businesses will be excluded from facilities provided by the government. In addition, informally operating firms will find building credit worthiness difficult as they rarely maintain systematic accounts and have limited documentation available to show the soundness of their businesses. Operating informally limits the possibility of upgrading for many businesses and they remain micro or small. One of the effective ways to convince businesses to get registered could be to simplify the registration processes and reduce compliances. For micro enterprises, taxes may not be an issue as the Government of Nepal exempts micro enterprises from income tax for seven years and women-led micro enterprises are exempted for 10 years.
Nara Bahadur Thapa: The informal sector does not have social security. As more of the informal sector is formalised more people end up more secure. The transparency of organisations increases as they are formalised. The effectiveness of policies created by the government to secure citizens goes up as well. The taxes collected by the government may go up as well. What will definitely happen is that the more accurate date that formalisation entails will help in drafting policies and budgets. These things can only be drafted on the basis of the formal sector. Thus, formalisation is a necessary step for the development of the nation, social security and justice, functioning of the systems, and effectiveness of policies.
Neelam Dhungana Timsina: The National Economic Census Report 2018 shows about half of the establishments are not registered businesses. This shows there is still a huge prospect for formalisation of businesses in Nepal. However, the formalisation of businesses should be done through a plan as a gradual process. At least, the process should not dampen the earnings of people. 
The substantial existence of the informal economy might be caused by several constraints i.e., geographical barriers, limited access to government services, bureaucratic hurdles, and a tendency to evade taxes. However, there’s an opportunity to formalise the informal sector by leveraging digital services, which can streamline procedures significantly. Digital payment systems, for instance, can aid in tracking informal businesses.
To transition informal sectors into formal channels, the government can create a favourable and simplified environment, initially focusing on incentives rather than from a revenue source perspective. This approach could involve tax exemptions for very small businesses in the early stages, while implementing regulations that ensure social security benefits for employees. This strategy aims to encourage informal businesses to register formally, thereby enhancing overall economic transparency and inclusivity. Further, there should be a seamless cooperation between three levels of government to bring the informal sector to formality through incentives and social benefits.
Rameshore Khanal: Most country’s revenue to GDP ratio is at around the 25% mark. Ours is not much different. If someone says that we are losing a lot of taxes to the informal sector they would be wrong. The character of our economy ensures that around 40 to 50% will be informal. This happens because 24% of our revenue comes from farming. These large amounts of farmers consume their own produce which is a substantial amount of consumption not counted in the GDP. Only around 30% of people in Nepal live in the cities. A lot of the business conducted in these villages, with 70% of the population, are outside the tax net. If it is below 50 lakhs it is not included in the VAT. A lot of small businesses need to only pay presentive taxes. So, a lot of businesses will foreseeably remain informal without much effect on the tax collected. To make sure that each and everyone receives the advantages and security that comes with being registered, an effort must be made to formalise more businesses.

What kind of effects will the concentration of wealth in Nepal cause?
Nara Bahadur Thapa: This concentration of wealth will have a political, economic and social effect. Politically the systems get captured by those with wealth power resulting in political systems getting defunct. Economically there is a danger of policies being made solely to cater to these people. The level playing field will not exist as more and more systems are changed for the profit of the elite. There may be a regulatory capture where the policies are not made any more for the benefit of the citizens but rather for the vested interest a select group of people have. Socially, this type of inequality is unacceptable. This will result in issues related to law and order and social unrest. Obviously, society will never be 100% fair, but it can be fairer. Some individuals have become richer by not paying taxes, getting favours from the government and generally exploiting the masses. A lot of people abuse and misuse the system. This happens because the richer the person the more likely to receive loans, which is wealth the public accumulated. Such systems benefit the rich as they get richer, but such systems do not help society as a whole get more prosperous. It is the state’s responsibility to take care of such matters as well.
Neelam Dhungana Timsina: Nepal Rastra Bank (NRB) has directed financial institutions (BFIs) to focus their lending on specific sectors and underserved groups with the aim of supporting productive sectors and improving conditions for marginalised groups. To promote lending diversity, NRB has set a Single Obligor Limit (SOL) restricting BFIs from lending more than 25% of their primary capital to any single individual or entity. Additionally, NRB has defined sector-specific lending limits to prevent over-concentration in any one sector of the economy. In its regulatory role, NRB ensures that BFIs diversify their lending across various sectors rather than concentrating it among a few individuals or sectors.
Based on macroeconomic and financial data from the first eleven months of 2080/081, 12% of total outstanding credit by BFIs is secured against current assets, while 68.5% is secured against land and buildings. This indicates the collateralisation of loans disbursed by BFIs.
Furthermore, NRB has introduced stress testing guidelines mandating BFIs to conduct stress tests quarterly and report the results to NRB. These stress tests include scenarios that assess credit risks, which also includes downgrades in large exposures. Stress tests help evaluate a bank’s resilience to adverse future scenarios, facilitating internal improvements and ensuring risks are communicated effectively within the bank and to the regulator.
Rameshore Khanal: In a wider sense this is the phenomenon known as wealth concentration, in this specific narrow sense it is known as credit concentration. Banks have been giving a large amount of loans to specific individuals and families. These are not given as a personal transaction but through the organisations they represent, but there is generally only one person or family who holds the majority stake in such organisations. I would say around 20% of these people have been availing around 80% of the loans in Nepal. This is not good for any country. This access to finance is something that Nepal is weak in. There have been provisions created to reduce related party lending and make loans more equitable, without which the inequality is only bound to increase more and more. 

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E-Magazine
NOVEMBER 2024

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