UNLOCKING
NEPAL’S GROWTH
POTENTIAL
NEPAL COUNTRY ECONOMIC MEMORANDUM
2025
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Contents
Acknowledgements	VII
Executive Summary	                                                                                     VIII
CHAPTER 1. Facts of Growth	                                                                              1
1.1. Nepal’s journey to lower-middle income status	                                                       2
1.2. Growth accounting and drivers	                                                                       5
      1.2.1. Expenditure approach	                                                                        6
      1.2.2. Production approach	                                                                        12
      1.2.3. Long-term growth	                                                                           14
1.3. Labor market developments 	                                                                        16
1.4. Looking ahead: Drivers of future growth 	                                                          19


CHAPTER 2. International Migration for Employment and Welfare	                                          22
2.1. International migration remains important, with increasing economic returns 	                      23
      2.1.1. Remittances contributed significantly to reducing poverty	                                 23
2.2. Pre-departure: The factors shaping the migration and destination choice 	                          26
     2.2.1. Migrants face high costs before departure	                                                  26
     2.2.2. Socioeconomic factors affect the destination choice	                                        27
2.3. During migration: The benefits for migrant-sending communities and households 	                    30
     2.3.1. Remittances strengthen household resilience and affect migrants’ home-communities 	         30
     2.3.2. But migration comes with considerable risks	                                                35
2.4. Post-migration: Remigration and reassimilation in the labor market	                                36
     2.4.1. Migrants struggle to effectively reassimilate 	                                             36
2.5. Looking ahead: Reducing costs, increasing benefits, boosting long-term growth 	                    37


CHAPTER 3. Real Exchange Rates, Trade Policy, and Exports in Nepal	                                     44
3.1. Introduction	                                                                                      45
3.2. The effect of bilateral RERs and trade policy on firm-level exports	                               47
      3.2.1. Overview of firm-level data in Nepal	                                                      47
      3.2.2. Bilateral exchange rates and exports	                                                      49
      3.2.3. Domestic trade policy and exports	                                                         49
      3.2.4. Partner country trade policy and exports 	                                                 50
3.3. The effect of remittances on REER dynamics	                                                        52
3.4. Looking ahead: Policy recommendations to boost exports	                                            54




                                                                      Nepal Country Economic Memorandum I I
CHAPTER 4. Unlocking Nepal’s Hydropower Potential to Enable Stronger Growth	      59
4.1. The current state of Nepal’s hydropower sector	                              60
4.2. The key impediments to hydropower development 	                              62
4.3. Avenues for economic growth through hydropower 	                             67
4.4. Looking ahead: How to boost hydroelectricity for economic growth 	           70


CHAPTER 5. The Digital Sector: A Driver of Growth and Job Creation	               73
5.1. The current state of Nepal’s digital sector 	                                74
      5.1.1. Overview of the digital economy	                                     75
      5.1.2. Progress in digital infrastructure 	                                 77
      5.1.3. Progress in digital adoption by firms	                               80
      5.1.4. Progress in digital adoption by households 	                         83
5.2. The key impediments to digital adoption	                                     84
5.3. How digital technologies can boost growth and jobs	                          89
5.4. Looking ahead: Policy recommendation to close the coverage and usage gaps	   90


References 	                                                                      94
Annexes	99
Endnotes	113




II I Nepal Country Economic Memorandum
List of Figures
Figure 1.1. Nepal’s economy grew slower than peers’ before 2014 and in line thereafter…	                      3
Figure 1.2. … the real output gap nevertheless widened compared to peers. 	                                   3
Figure 1.3. GNI per capita lost ground against peers…		                                                       3
Figure 1.4. … and current growth rates are not sufficient to catch up in the long-term 	                      3
Figure 1.5. Remittance inflows increased significantly over time…	                                            4
Figure 1.6. …and contributed to the poverty reduction.		                                                      4
Figure 1.7. Private consumption has been the biggest contributor to growth in Nepal…	                         6
Figure 1.8. ... and its share in GDP remained high over time. 	                                               6
Figure 1.9. Remittances financed Nepal’s growing trade deficit…		                                             7
Figure 1.10. … which was driven by stagnating exports. 	                                                      7
Figure 1.11. Real exchange rates appreciated…	                                                                8
Figure 1.12. … which appears correlated with the increase in remittance inflows. 	                            8
Figure 1.13. The tradeable sector ratio declined while remittance inflows increased… 	                        9
Figure 1.14. …and Nepal was relatively closed to cross-border financial flows. 	                              9
Figure 1.15. Services were the key component of growth on the supply side…	                                  12
Figure 1.16. … and accounted for a high share of the economy. 	                                              12
Figure 1.17. Construction became the largest component of the industry sector... 		                          14
Figure 1.18. … wholesale and retail services of the services sector. 	                                       14
Figure 1.19. Capital accumulation drove long-term growth.	                                                   15
Figure 1.20. The efficiency-enhancing reallocation of workers was slow in Nepal.		                           16
Figure 1.21. Nepal’s annual employment ratio change was negative from 2000 – 2022…	                           17
Figure 1.22. … and non-agriculture employment in 2022 was lower than in peers. 	                              17
Figure 1.23. Labor Productivity in 2022	                                                                     18
Figure 1.24. Labor Productivity by Sector in 2022	                                                           18
Figure 1.25. Agriculture - Deviation from EMDE long-run employment ratio	                                    19
Figure 1.26. Non-Agriculture - Deviation from EMDE long-run employment ratio	                                19
Figure 1.27. Baseline growth projections are significantly below authorities’…	                              20
Figure 1.28. … reflecting lower capital accumulation over the medium- to long-term. 		                       20
Figure 1.29. Higher productivity and factor accumulation would boost growth…	                                20
Figure 1.30. … while permanent outmigration and lower remittances would slow it. 	                           20
Figure 2.1. International migration from Nepal is high and mostly for economic work.		                       23
Figure 2.2. Personal remittances as a share of GDP remain high…		                                            24
Figure 2.3. … and per capita receipts have increased across the wealth distribution. 	                       24
Figure 2.4. Economic migration is a young and male phenomenon…	                                              25
Figure 2.5. … and concentrated among those with intermediate/high school education or less. 	                25
Figure 2.6. However, there is a gradual shift towards more skilled occupations,
	           and average earnings overseas are also increasing. 	                                             25
Figure 2.7. Access to higher remunerative migration destinations improved over the last
	           decade but remained unequal across provinces…		                                                  27




                                                                         Nepal Country Economic Memorandum I III
Figure 2.8. … and across wealth decile.		                                                                       27
Figure 2.9. While Nepali migrants face one of the highest migration costs relative to per capita GDP.	          27
Figure 2.10. There is a strong wealth and migration association by destination 	                                28
Figure 2.11. … and it has important implications both on the frequency and amount of
	            remittance migrants send home.	                                                                    29
Figure 2.12. Remittances are primarily used for daily consumption and repaying loans.	                          29
Figure 2.13. Financial flows from migrants abroad account for significantly more of
	            Nepali households’ finances across the distribution than their peers in the region.	               30
Figure 2.14. Household expenditures have improved across the distribution.	                                     30
Figure 2.15. Remittances from a member abroad are strongly linked with human capital investments.	              31
Figure 2.16. Adequacy of family’s standard of living and food security.	                                        35
Figure 4.1. Hydropower potential and installed capacity in MW	                                                  60
Figure 4.2. Components of overall domestic energy production in 2022 in percent of total.	                      60
Figure 4.3. Per capita electricity generation in 2022	                                                          61
Figure 4.4. Installed hydro capacity by Nepal Electricity Authority and Private Sector in MW	                   61
Figure 4.5. Per capita electricity consumption (Kwh) in 2022		                                                  66
Figure 4.6. Household energy consumption in TJ 	                                                                66
Figure 4.7. Industry energy consumption in TJ	                                                                  66
Figure 4.8. Services energy consumption in TJ	                                                                  66
Figure 5.1. Key segments in the digital sector	                                                                 74
Figure 5.2. Nepal is competitive in exporting digitally delivered services… 	                                   76
Figure 5.3. … and employment in ICT services, while still small, is higher than in many peers.	                 76
Figure 5.4. Mobile broadband network coverage has expanded…	                                                    78
Figure 5.5. … but the network quality lags peers.	                                                              78
Figure 5.6. Monthly traffic of internet exchange point (ISXP) and number of connected data
	           center per million people	                                                                          79
Figure 5.7. Digital technologies adoption by firms in South Asia	                                               81
Figure 5.8. Small firms saw the largest increase in website usage between 2013 and 2023…	                       81
Figure 5.9. … and the retail sector experienced the largest usage increase between 2013 and 2023	               81
Figure 5.10. Digital payment usage varies widely across firm sizes…	                                            82
Figure 5.11. … and sectors.	                                                                                    82
Figure 5.12. Tangible ICT capital per worker grew faster…	                                                      82
Figure 5.13. ... than that of intangible ICT capital per worker	                                                82
Figure 5.14. Prices for data-only mobile-broadband basket (2GB) remain high as a share of
	            monthly GNI per capita…		                                                                          84
Figure 5.15. … as do prices for fixed broadband basket (5GB) as a share of monthly GNI per capita.		            85
Figure 5.16. Duration of internet disruption and the impact of disruption on sales were larger for small firms…	 86
Figure 5.17. … and firms in “other services” sector.	                                                           86




IV I Nepal Country Economic Memorandum
List of Tables
Table ES1. Policy recommendations to improve migration outcomes	                                  XXIII
Table ES2. Policy recommendations to boost exports	                                               XXIII
Table ES3. Policy recommendations to boost hydropower development	                                XXIV
Table ES4. Policy recommendations to boost digitalization	                                        XXIV
Table 2.1. Local labor market spillovers	                                                           31
Table 2.2. Annual earnings for daily wage workers increase with higher migration rates and
	          return on education is high across migration rates.	                                     33
Table 2.3. Policy recommendations to improve migration outcomes	                                    38
Table 3.1. Firm-level export patterns	                                                              48
Table 3.2. Mean values for regression variables	                                                    53
Table 3.3. Policy recommendations to boost exports	                                                 55
Table 4.1. Policy recommendations to boost hydropower development	                                  70
Table 5.1. Policy recommendations to boost digitalization	                                          91




                                                                  Nepal Country Economic Memorandum I V
VI I Nepal Country Economic Memorandum
Acknowledgements
This report is a product of the World Bank’s Economic Policy Global Department. The preparation was led by Se-
bastian Essl (Senior Economist) and Nayan Krishna Joshi (Country Economist), the core team further comprised
Lokendra Phadera (Economist), Rishi Sharma (Associate Professor of Economics, Colgate University), and Sarita
Sapkota (Economist).

The authors of the individual chapters are as follows:

Chapter 1 on facts of growth was prepared by Sebastian Essl, with contributions from Zoe Leiyu Xie (Senior Econo-
mist), Nayan Krishna Joshi, and Thi Thanh Bui (Economist).

Chapter 2 on migration was prepared by Lokendra Phadera and Sarita Sapkota, with comments from Ximena Del
Carpio (Practice Manager), Nandini Krishnan (Lead Economist), Nethra Palaniswamy (Senior Economist), and Alvin
Etang Ndip (Senior Economist). The team is grateful for the Nepal Living Standards Survey data provided by the
Nepal Statistics Office.

Chapter 3 on exports was prepared by Rishi Sharma, with comments from Sebastian Essl.

Chapter 4 on hydropower was prepared by Sebastian Essl with comments from Nayan Krishna Joshi, Subodh
Adhikari (Senior Energy Specialist), and Govinda R. Timilsina (Senior Economist).

Chapter 5 on digitalization was prepared by Nayan Krishna Joshi, with comments from Siddhartha Raja (Senior
Digital Development Specialist) and Sebastian Essl.

The report was prepared under the guidance of Shabih Ali Mohib (Practice Manager). The team is grateful for further
valuable guidance received from Gregory Smith (Program Lead) and David N. Sislen (Country Director). Excellent
peer review comments were provided by Gonzalo Varela (Lead Economist), Jan Hansen (Asian Development Bank),
and Maheshwor Shrestha (Senior Economist). The team appreciates further valuable comments from Nepal Rastra
Bank and the South Asia Watch on Trade, Economics and Environment. Akash Shrestha (External Affairs Officer)
and Avinashi Paudel (External Affairs Associate) managed media relations and dissemination. Anima Maharjan (Pro-
gram Assistant) managed the publication process




                                                                    Nepal Country Economic Memorandum I VII
Executive Summary
Nepal has achieved remarkable success in reducing poverty over the past three decades, virtually eradicating
extreme poverty. In 1995, an estimated 55 percent of Nepalis lived in extreme poverty, defined by the US$ 2.15 per
day threshold. Although the trend is not strictly comparable, by 2023, this figure had plummeted by an astounding
54.8 percentage points, with just 0.37 percent of the population living below this line. The speed and scale of Nepal’s
success in eliminating extreme poverty are unparalleled among its peers. Moreover, this progress was not confined
to extreme poverty. The broad-based and deep reduction is evident in the poverty headcount ratio measured at US$
6.85 per day, which fell from 90 percent to below 50 percent over the same time.

However, this reduction in poverty was not fueled by rapid economic growth, as Nepal’s economy struggled
to keep pace regionally and globally. Nepal’s economy grew at a real 4.2 percent annually between 1996-2023, re-
spectable considering a domestic conflict and multiple shocks affecting the country. Nepal’s economic development
nevertheless lagged that of peer countries. Within South Asia, Nepal’s growth rate ranks sixth out of eight countries,
surpassing only Pakistan and Sri Lanka. Both structural and aspiration peers outperformed Nepal as well.

The key factor behind the poverty reduction and resilience in the wake of shocks has been migration and the
inflow of remittances. By 2023, over 7 percent of Nepal’s population had migrated abroad in search of employ-
ment due to limited domestic job opportunities. Most of these migrants are young men, primarily seeking work in
Gulf Cooperation Council (GCC) countries and Malaysia. This large-scale outmigration led to a substantial increase
in remittances and the number of households receiving them. By 2023, remittances accounted for around a quarter
of Nepal’s GDP, playing a crucial role in sustaining the economy and lifting many out of poverty. The direct impact
of remittances on poverty has been significant and transformative.

Significant structural challenges constrain domestic economic growth and job creation. Exports have not con-
tributed to real economic growth over the past decades, partly due to an appreciating real exchange rate and domes-
tic trade policies, including high tariffs and excise taxes. Weak competition in logistics and transport have further lim-
ited the potential for a dynamic export sector. The manufacturing sector has been in steady decline from an already
low base, while the tourism sector, a key growth and job opportunity, remains underdeveloped. The development of
hydropower has progressed slowly, restricting its potential to shape the economy and facilitate stronger growth.
Limited infrastructure, regulatory challenges, and digital literacy gaps are holding back the country’s digitalization
efforts. Because of these constraints, Nepal has struggled to ignite higher domestic growth and create sufficient jobs.

Current policies fall short of achieving Nepal’s ambitious growth targets and raising income to peers’ levels.
The 16th Development Plan envisions an average annual real GDP growth rate of 7.1 percent until 2029, far above
historical averages. Baseline projections, however, estimate that potential long-term real growth will hover around 4
percent. If Nepal achieves higher growth rates, GDP per capita could increase faster, enabling the country to narrow
the income gap with peer countries. However, if growth continues at historical rates, Nepal’s income level would
reach only 65 percent of structural peers’ levels, and less than one-third of its aspirational peers’ by 2050. Bridging
this gap requires a decisive policy shift to achieve and sustain higher growth.

Unlocking opportunities for growth is the first step toward achieving Nepal’s development aspirations. Pol-
icies must unlock the potential of high-promise sectors and support private sector development. Facilitating firm
creation, boosting export growth, and attracting domestic and foreign investment can open new pathways for
growth. Targeted support for sectors such as hydropower, tourism, and digital services can generate significant
economic and employment opportunities. Achieving this, however, requires addressing regulatory hurdles, improving
infrastructure, and fostering a more competitive business environment. Additionally, improving migration policies to
increase benefits and reduce costs for migrants can further contribute to economic development.




VIII I Nepal Country Economic Memorandum
To fully realize these opportunities, Nepal must build the capabilities needed to translate potential into
growth. Strengthening workforce skills, enhancing institutional capacity, and improving firms’ competitiveness are
critical to boosting productivity and resilience. Without these efforts, potential growth could fall below 4 percent
over the long-term, undermining national ambitions. Nepal also needs to enhance its capacity to manage migration
patterns and remittance flows. Building these capabilities will enable the country to capitalize on emerging opportu-
nities, withstand shocks like natural disasters better, and achieve sustained and inclusive growth.

This report aims to help policymakers identify key growth opportunities and offers recommendations for
building the capabilities needed to realize them. Chapter 1 analyzes growth trends across three key periods,
highlighting factors that could accelerate or hinder future progress. Chapter 2 focuses on policies to maximize the
economic benefits of migration. Chapter 3 examines how exchange rate dynamics and trade policies affect Nepal’s
merchandise exports and provides strategies for boosting them. Finally, Chapters 4 and 5 explore how Nepal can
harness the potential of hydropower and digitalization, two promising drivers of future growth.


Facts of growth
Nepal’s economic development since 1996 can be divided into three distinct periods, each shaped by signifi-
cant challenges. The first one, the conflict period from 1996-2006, was defined by a decade-long conflict between
the government and the Communist (Maoist) Party of Nepal, which disrupted the economy and fueled international
migration. Increasing numbers of Nepali workers sought employment in Gulf Cooperation Council (GCC) countries
and Malaysia. This trend continued during the post-conflict period (2007–2014), which, despite the signing of a
peace treaty, was marred by political instability and frequent changes in government. The third phase, from 2015-
2023, was dominated by repeated shocks, including the devastating 2015 Gorkha earthquake, India’s blockade, a
major landslide in 2017, and the global COVID-19 pandemic, all exacerbated by ongoing political instability.

Nepal’s growth performance throughout these periods is benchmarked against a set of structural and aspi-
rational peer countries. Both were selected based on economic characteristics that closely resemble those of Ne-
pal, including geography, strong remittance inflows, and significant hydropower potential. Structural peers include
Bangladesh, Bolivia, and Kyrgyz Republic. Aspirational peers, which have achieved higher income levels, include
Cambodia, Lao PDR, and Moldova.

Political unrest hampered growth in the conflict period from 1996-2006. The decade-long armed conflict be-
tween the government and the Communist (Maoist) Party of Nepal disrupted both political and economic stability.
During this period, growth averaged a modest 4 percent, trailing behind structural and aspirational peers, who grew
at 4.4 and 5.9 percent on average. The conflict hindered investment and stunted job creation, yet, amid the turmoil,
remittances from the increasing number of Nepali workers abroad provided a critical lifeline for the economy.

The end of the armed conflict after the signing of a peace treaty in 2006 would have provided the opportu-
nity for Nepal to harvest a peace dividend. However, a surge in growth failed to materialize during the post-con-
flict period from 2007-2014. Political instability persisted in the form of frequent changes in government and delays
in the adoption of a new constitution. These factors limited the country’s ability to capitalize on the end of the
conflict. Growth did improve slightly though, rising to an average of 4.6 percent, but still below the rates observed
in structural and aspirational peers.

Repeated shocks tested the resilience of the economy between 2015-2023. In 2015, Nepal was struck by a
devastating earthquake, killing thousands, displacing millions, and causing the widespread destruction of infra-
structure. Just months later, the country faced an economic blockade by India, which further strained its economy.
These crises were followed by further natural disasters and the COVID-19 pandemic, which severely disrupted global
economic activity. Nepal’s economy nevertheless maintained an average growth rate of 4.2 percent, slightly above
aspirational peers and on par with structural peers.



                                                                      Nepal Country Economic Memorandum I IX
Due to overall lagging growth, Nepal’s real income level remains significantly below that of its peer countries.
Between 1996-2023, Nepal’s Gross National Income (GNI) per capita increased by an average 7.3 percent annually,
supported by slow population growth. Although slower growth among structural peers allowed Nepal to narrow the
income gap somewhat, its income level still stands at only half that of structural peers. The disparity with aspira-
tional peers has even widened, and by 2023, Nepal’s GNI per capita had reached just 40 percent of theirs. Looking
ahead, without reforms to accelerate growth, Nepal is unlikely to close the income gap with its peers, and achieving
upper-middle income status could take more than 20 years.

Nepal’s growth model has relied heavily on remittances, which contributed significantly to the remarkable
reduction of poverty. Between 1996-2023, authorities issued more than 6.6 million new labor approvals for mi-
grant workers and by 2023, more than 7 percent of the total population was living abroad. As a result, remittances
more than tripled from an average 7 percent of Gross Domestic Product (GDP) during the conflict period to 25
percent of GDP during the period of repeated shocks. They also directly contributed to the eradication of extreme
poverty by 2023.

Remittance-driven consumption and the service sector were the main sources of growth. On the demand side,
remittances sustained private consumption and kept economic activity afloat, even as multiple shocks hit the econ-
omy. During the period of repeated shocks, private consumption accounted for 3.6 percentage points of real growth,
up from 3.1 percentage points during the conflict period. Its share in real GDP consequently reached 80 percent on
average during the repeated shocks. This stands in clear contrast to structural and aspirational peers, where private
consumption accounted for significantly less of real growth and its share in real GDP was lower. Services were the
main source on the supply side, accounting for 2.3 percentage points of real growth and accounting for half of real
GDP during the repeated shocks period. Capital accumulation was the primary driver of real economic growth, while
labor and total factor productivity (TFP) contributed minimally.


Exports and the industry sector have contributed little to economic growth
Nepal’s economy faces a range of structural challenges that hinder stronger growth. Exports have not con-
tributed much to growth in Nepal. The manufacturing sector, historically an engine of growth in other developing
countries, has been on a constant decline. Increasing remittances have also not translated into significant job cre-
ation or higher productivity in key sectors. The country’s labor market struggled to create sufficient jobs and labor
productivity lags its peers. Overall productivity remains low and has not contributed significantly to growth.

First, Nepal is yet to boost economic growth and job creation through exports of goods and services. A thriv-
ing export sector could have enhanced productivity, created higher-quality jobs, and attracted foreign investment,
which would bring new technology and diversify the economy. However, exports of goods and services have re-
mained stagnant, contributing only 7 percent to GDP since 2015, far below its peers. The trade deficit widened as
remittances were increasingly used to finance imports. The COVID-19 pandemic further exacerbated the situation,
reducing exports to a record low of 5 percent of GDP in 2021.

The appreciation of the real effective exchange rate (REER) caused a loss of price competitiveness and was
an important factor in Nepal’s export slump. The country’s low merchandise exports are often linked to high
trade costs due to its mountainous terrain and poor physical infrastructure. But a Dutch Disease-like effect may
have eroded price competitiveness over time, with rising remittances driving domestic non-tradeable prices, thereby
appreciating real exchange rates. This effect was further exacerbated by Nepal’s fixed exchange rate with the Indian
Rupee, which has not been adjusted since 1993, even as inflation differentials with key trading partners have wid-
ened. This made merchandise exports less attractive and contributed to the persistent trade deficit.

Other critical factors limiting merchandise exports include domestic trade policies and restrictions on
cross-border capital flows. Capital flow restrictions, introduced to maintain monetary autonomy, have made Ne-
pal less open to international financial flows compared to its peers, deterring foreign investors who could have



X I Nepal Country Economic Memorandum
brought in new technology, know-how, and capital. High tariffs and trade taxes have created an anti-export bias,
raising costs for domestic producers and reducing their competitiveness. Tariffs on intermediate goods in particular
increase production costs, making it difficult for Nepali firms to upgrade the quality of their products and expand
into higher-value markets. Political instability and policy uncertainty have added to the challenges, with frequent
changes in government delaying reforms and deterring both domestic and foreign firms from investing in export-ori-
ented sectors.

Second, Nepal’s industry sector output has been on a constant decline, mirroring the trend of exports. The
share of industry in real GDP remained at a low 14 percent over time, contributing only 0.8 percentage points to
growth on average. Peer countries, on the other hand, have seen some growth in their industrial sectors. The slump
is particularly evident in manufacturing, which has been on a constant decline in Nepal, falling from 7.3 percent of
real GDP during the conflict period to 5.7 percent during the repeated shocks period. Construction has overtaken
manufacturing as the largest subsector, but both sectors contracted in 2023 due to import restrictions.

Third, low overall productivity has both been a reason and consequence of lagging growth, low exports, and
stagnating manufacturing output. The contribution of total factor productivity (TFP) to economic growth varied
significantly over time. During the conflict period it contributed only 0.25 percentage points to real growth, reflecting
political instability and disruptions to economic activity caused by the insurgency. Although TFP recovered some-
what in the post-conflict period, its contribution to growth effectively vanished during the repeated shocks period,
reflecting the impact of various shocks. In turn, the poor export performance and stagnant manufacturing sector
have hindered productivity improvements, perpetuating the cycle of low productivity and weak economic outcomes.

Finally, Nepal’s employment structure is heavily reliant on agriculture, with a relatively low share of jobs in
non-agricultural sectors compared to peer countries. Women face greater challenges, as they are more likely to
be employed in informal and low-productivity agricultural roles. The slower pace of job creation in non-agriculture
sectors has disproportionately affected women, whose participation in non-agricultural jobs remains lower than the
national average. Although Nepal has a higher employment ratio for women compared to other South Asian coun-
tries, most of these jobs are informal, offering limited security and opportunities for advancement.

Labor productivity remains a significant concern, as the country ranks lowest among its peers. Agriculture,
which accounts for a large portion of employment, remains the least productive sector. Productivity growth in the
industry and services sectors has also been sluggish, further contributing to low overall productivity. The widespread
informality and subsistence nature of many jobs, particularly in agriculture, are key factors behind this issue. With
over 80% of the workforce in the informal sector, improving the formalization of jobs and increasing productivity in
non-agriculture sectors are crucial for boosting Nepal’s economic growth.

To boost employment growth, Nepal needs to implement policies that focus on increasing trade openness,
improving access to finance, and enhancing educational outcomes. These steps could help raise the non-agri-
culture employment ratio and overall job creation by up to 3 percentage points in the long run. By fostering a more
educated workforce, removing trade barriers, and enabling easier access to finance, Nepal could stimulate job-rich
growth, leading to higher productivity and more secure job opportunities for both men and women.

Comprehensive policies are needed to improve the competitiveness of Nepal’s economy. Better managing in-
flation and revising the current tariff and excise tax structure are critical, but not sufficient to improve export per-
formance. Additional policies on key export-enabling domestic sectors will be required to improve competition and
market structure and reduce barriers to entry into logistics or transportation. Particularly ICT service exports appear
to hold promise for increasing export-led growth and should be supported by targeted policies. Similarly, targeted
policies to increase domestic hydroelectricity production and improve its reliable transmission and distribution could
improve the comparative advantage of domestic goods and services. With migration likely remaining a key growth
factor, policies improving migration outcomes are also critical.




                                                                        Nepal Country Economic Memorandum I XI
Increasing the returns of migration
Migration is an important job strategy for young Nepali workers, offering significant economic
benefits
International migration for employment remains a cornerstone of Nepal’s economy and livelihoods. In 2021,
approximately one-fourth of households had at least one family member abroad, representing 7.5 percent of the
country’s population. Nepalese workers’ remittances were worth over 25 percent of GDP in 2023, placing Nepal
among the top 10 remittance-receiving countries globally. These remittances surpass foreign direct investment and
foreign aid and remain a vital source of foreign exchange. Despite a rise in migration for educational purposes over
the last decade, employment-related migration continues to dominate, significantly easing domestic labor market
strains. Notably, 17 percent of the male working-age population, roughly 10 percent of the overall working-age pop-
ulation, resided abroad in 2021.

Remittances play a pivotal role in uplifting the living standards and resilience of the origin communities, with
remittances directly contributing to over 30 percent of Nepal’s poverty reduction between 2011 and 2023.
They benefit households across the wealth distribution, with an increasing number reaping their rewards. Remit-
tances have contributed to increasing household consumption and higher investment in education and healthcare.
Having a member abroad also significantly correlates with households suffering less from inadequate family living
standards and food insecurity.


Migration opportunities remain unequal, and moving abroad can be taxing
Migration from Nepal is expensive, and while it offers economic benefits, these come with significant bur-
dens for both the migrants and the family members left behind. Migrant workers often rely on informal loans
with exorbitant interest rates to finance their costly moves. After daily consumption, repaying loans is households’
most cited use of remittances. While the families left behind face disruption in their social and domestic lives, having
members abroad is also associated with their reduced labor force participation, particularly women. Migrant work-
ers, on the other hand, are likely to endure challenging working and living conditions without access to healthcare
or social protection. Yearly deaths of migrant workers have exceeded 1,000 in recent years. They also face contract
fraud and employer exploitation, including withholding travel and legal documents. These adverse work conditions
and lack of social support, coupled with the constant pressure to send remittances home, can have detrimental
effects on migrants’ mental and physical health.

Despite more equitable access to migration opportunities over the past decade, liquidity constraints limit
household migration and influence destination choices. Migration patterns are shaped by economic status, social
caste/ethnicity, and geographic location. Poorer households are likely to send members to low-cost and low-return
India. At the same time, those from the middle wealth brackets prefer the GCC and Malaysia destinations, which have
medium-costs and medium-returns. Migration to the most lucrative Western, Asian, and Pacific (WWAP) destina-
tions remains predominantly accessible to the wealthiest, who can afford the high migration costs. Provincial migra-
tion rates reflect similar trends, with India being a key destination for the poorest provinces of Sudurpashchim and
Karnali. In contrast, wealthier provinces such as Bagmati favor more premier destinations. These patterns have im-
portant implications as households’ wealth levels are strongly correlated with the frequency and size of remittances
received, with migrants from the wealthiest decile sending over five times more than those from the lowest decile.


Reassimilation of migrants upon their return remains a challenge
Reintegrating return migrants poses a considerable challenge, exacerbated by the mismatch between the
skill acquired abroad and demand in the domestic labor market. Based on the Nepal Labor Force Survey 2017/18,
one of the few data sources on returnees, most of the returnees were either unemployed (14.3 percent) or remained
out of the labor force (41.5 percent), and even among those with jobs, over 75 percent were employed in the informal



XII I Nepal Country Economic Memorandum
sector. Only a minority could secure employment in the same occupational category as their overseas jobs and use
their acquired skills. Compared to non-migrants, returnees also earn less, at least initially.


A systematic and inclusive migration management system could provide stability and maximize
rewards
Establishing an effective institutionalized migration system is critical for sustainability and improving re-
turns. Drawing on current evidence and lessons from other countries, such as the Philippines, the priority should be to
ensure that migration is a safe and viable livelihood option for Nepalis across the population domains. Efforts should
focus on increasing benefits and reducing migration costs for contemporaneous predominantly low-skilled economic
migration with an eye for longer-term skill and destination diversification. This will entail improving migrant prepar-
edness through education and training, raising awareness, enhancing financial and regulatory literacy, establishing
a transparent and systematic recruitment process, and planning for longer-term upskilling. Additionally, engaging in
bilateral agreements and actively participating in their implementation and timely updating will be crucial.

Besides focusing on safer and more remunerative migration, the reintegration of returnees is as important.
Retraining and reskilling programs and initiatives promoting returnees’ entrepreneurship could improve returnees’
job matches in the domestic labor market. Such initiatives are currently limited and out of reach for most. Addi-
tionally, soft skills such as work ethic, time management, and communication, which are highly transferable and
often enhanced while working abroad, can be valuable in Nepal’s growing service sector. However, these skills are
often overlooked. A better understanding of how to combine these soft skills with industry-specific reskilling could
reduce labor market friction and improve returnees’ job placements. Ultimately, addressing the structural issues in
the domestic labor market will not only support the reassimilation of returnees but also improve opportunities for
those left behind and broaden their choices if faced with migration decisions.


Increasing export competitiveness through monetary and trade
policy
Nepal’s export competitiveness eroded over the past decades

Nepal experienced a staggering loss of export competitiveness over the past decades. The country’s exports-
to-GDP ratio fell from over 25 percent in the late 1990s to a mere 6.8 percent in 2022, with merchandise exports-
to-GDP particularly low at approximately 3.2 percent. Despite decent growth in real GDP and imports, real exports
have remained largely stagnant over time.

Exports lack diversification in terms of products and destinations and have been low value. ICT services ex-
ports account for over 8 percent of services exports and over 4 percent of total exports in 2023. In terms of des-
tination, more than two-thirds of total goods exports go to India, while the shares of geographically close trading
partners like Bangladesh, China, or Pakistan are negligible. Finally, only 0.5 percent of manufacturing exports were
classified as high-tech in 2022, significantly below the shares in several peer countries.

High trade costs are a critical factor contributing to the low level of exports. The landlocked geography and
mountainous terrain increase the costs of transporting and trading goods. The challenging topography is paired with
subpar infrastructure, as Nepal ranks poorly on the quality of its road and air transportation infrastructure, evidenced
by low global competitiveness ratings. The lack of market competition in the transportation and logistics sector, par-
ticularly through the pervasive presence of syndication, further amplifies these high trade costs (Rajkarnikar, 2010).
The World Bank B-Ready 2024 report ranks Nepal in the lowest quintile globally in market competition. In addition
to the physical infrastructure gap, the National Quality Infrastructure, which comprises safety and health standards
amongst others, is also low and has led to Nepali exports being rejected by several countries.



                                                                      Nepal Country Economic Memorandum I XIII
Macroeconomic and trade policies are key factors in determining Nepal’s merchandise export performance.
There is currently little empirical evidence on the determinants of the country’s merchandise export performance at
the micro level. To fill this gap, this report uses firm-level customs data from 2011-2015 and 2018-2021 to analyze
the effects of RERs and domestic and foreign trade policies on exports. In addition, the chapter also provides some
evidence on the link between remittance inflows and the REER. To link the estimated real exchange rates (RER) to
remittances, the chapter includes a cross-country analysis of the relationship between remittances and REERs in
South and South-East Asia.


The appreciation of RERs and trade policy have contributed significantly to the export slump
The analysis reveals a significant adverse effect of the RER appreciation on Nepal’s exports, particularly
pronounced among larger firms and those with less diversified operations. A 10 percent increase in the bilateral
RER leads to a 3 percent decrease in exports. The RER effect is more pronounced for larger firms, those with exports
greater than the sample median. This may be due to smaller firms engaging in less systematic exports, driven to
a lesser extent by price competitiveness, while the opposite holds true for large firms. The RER effect is weaker for
firms with export destinations and products above the sample median, which indicates that more diversified firms
are better able to absorb fluctuations in bilateral RERs without having to adjust their export volumes.

Over the sample period from 2011 to 2021, the appreciation of the average bilateral RER has lowered Nepal’s
exports by more than 10 percent. Nepal’s average bilateral RER increased substantially over time, consistent with
the real bilateral appreciation against India and the rest of the world highlighted in Chapter 1. In addition, results
point to a stronger effect on exports to India, by far the most important export destination for Nepali firms, account-
ing for more than two-thirds of total goods exports.

The substantial inflow of remittances was a key driver of the RER appreciation and low labor force participation
exacerbated the effect. Nepal’s REER has appreciated by about 35 percent since the current peg with India was set
in 1993, reducing the competitiveness of merchandise exports. The appreciation is linked to the surge in remittances,
which increased from 2 percent of GDP in 2000 to 25 percent in 2025 and has raised concerns of a Dutch disease-like
effect. The analysis confirms these concerns and finds that the observed increase in remittances could account for a
REER appreciation of about 16 percent since 2000, roughly half the observed total. Consistent with past studies, the
estimated exchange rate model provides evidence of a RER overvaluation. The analysis also finds that the exchange
rate effect of remittances is larger in countries with a low labor force participation rate, which is the case in Nepal.

Domestic and foreign trade policies create additional barriers to exports. Nepal’s input tariffs are relatively high
and constitute a barrier faced by exporting firms. While the government implemented tariff drawback policies for
exporters designed to reduce this burden, there is a perception among the business community that they can be
difficult to obtain in practice. Another important challenge for Nepal lies in securing and taking advantage of mar-
ket access in other countries. Nepal does not have free trade agreements (FTAs) with countries outside the region,
and its scheduled graduation from Least Developed Country (LDC) status in 2026 would cause many existing LDC
preferences to eventually expire.

Domestic input tariffs, as expected, had a significant negative effect on Nepal’s exports. A 1 percentage point
increase in input tariffs results in a 2 percent reduction in exports. The substantial increase in domestic input tariffs
between 2011 and 2021 therefore resulted in roughly 8 percent lower exports over the same time. Unsurprisingly, the
effect of higher tariffs is amplified for firms in industries that are more dependent on imported inputs. The results
also show a greater response to input tariffs from firms that export to more destinations or more products. Unlike in
the case of a RER appreciation, however, the effect is more pronounced for smaller firms. This finding is consistent
with administrative challenges in obtaining duty drawbacks, which may be amplified for smaller firms.

Preferential market access for Nepali exporters in the form of lower partner country tariffs, on the other hand,
had a positive effect on exports. A 1 percentage point decrease in tariffs on Nepalese goods boosts exports by 0.8



XIV I Nepal Country Economic Memorandum
percent, while a similar increase in average tariffs in destination markets also enhances exports by 0.8 percent, indi-
cating the significant positive effect of preferential tariffs, which accounted for roughly 3 percent increase in exports
over this time. Both effects were stronger for larger firms, who accounted for the bulk of Nepal’s exports. This could
again indicate that smaller firms engage less systematically in exports, while larger firms are hit harder by changes in
their price competitiveness. Finally, findings show that a reduction in the foreign tariff applied to Nepal induces more
firms to export to this market for any given tariff level, highlighting another benefit of preferential market access.


Active trade and monetary policy could help to improve export competitiveness
These analytical results shed light on several significant macroeconomic and trade policy determinants of
Nepal’s merchandise export patterns. They highlight the impact of RERs, domestic input tariffs, and trade poli-
cies of partner countries on Nepal’s merchandise export performance. The findings reveal that the observed increase
in Nepal’s REER rate over the past decades has contributed to a decrease of about 10 percent in merchandise ex-
ports. Similarly, current input tariffs are estimated to have led to a reduction in exports by about 8 percent, while
preferential trade policies from partner countries could potentially increase merchandise exports. Additionally, the
chapter links remittances to the appreciation of the REER, suggesting that about half of the increase in Nepal’s
REER can be attributed to the surge in remittances.

Policies to manage inflationary pressures would address the REER effects and help Nepal’s export perfor-
mance. The peg of the Nepalese rupee to the Indian rupee implies that Nepal’s bilateral RER with India appreciates
when inflation exceeds that of India. In addition, the effect of India’s inflation on their nominal exchange rate will
indirectly affect Nepal’s RERs. Limiting inflation vis-à-vis India would therefore strengthen export competitiveness
by limiting the overvaluation of Nepal’s REER. That said, lowering inflation at or below India’s rate is a difficult task,
given the fixed exchange rate and the dependence on imports from India.

Set in 1993 and unchanged since, Nepal’s exchange rate peg warrants reconsideration in today’s economic
context. Fixed at a time when the economic environment was markedly different, the peg’s alignment with today’s
economic realities, considering persistent inflation differentials with India and significant trade imbalances, may no
longer hold. Although the peg has provided a degree of monetary stability, evolving macroeconomic fundamentals
suggest that its benefits could be diminishing. A joint review by the Ministry of Finance and Nepal Rastra Bank could
explore if shifting to a more flexible regime, such as a crawling peg, might be more suitable, balancing potential
longer-term benefits to competitiveness with the possible short-term pressures to inflation.

Policies that encourage the use of remittances and savings for more productive purposes would mitigate the
effect of remittances on the REER. The bulk of remittances are used for basic every-day consumption and the
repayment of migration loans. New financial instruments could nevertheless provide incentives to channel part of
remittances and more general savings into capital formation and less inflationary uses.

Improving the current duty drawback systems and reducing the input tariff burden directly would stimu-
late exports. Ensuring the effectiveness of duty drawbacks could increase exports, particularly from smaller firms.
While larger firms account for the bulk of exports, smaller firms provide an important contribution with their more
experimental export participation that helps determine a country’s comparative advantage. This measure could
be complemented by a direct reduction in input tariffs, including excise taxes that are designed as de-facto tariffs.

Finally, authorities should seek to extend LDC preferences and pursue additional preferential trade agreements.
Efforts to extend LDC preferences could focus on highlighting Nepal’s status as a landlocked developing country and
could reduce or even reverse the negative effects of the country’s graduation from LDC status in 2026 on exports.
Securing additional trade agreements through enhanced trade diplomacy would diversify currently limited export des-
tinations, which, in turn, would stimulate the diversification of export products since demand and domestic production
in India likely differs from other export destinations. The detailed list of recommendations is added in Tables ES1-ES4.




                                                                        Nepal Country Economic Memorandum I XV
Boosting long-term growth through hydropower
Hydropower could enable stronger growth in the long-run, domestically and through exports
Hydropower has the potential to transform the structure of the economy and shape economic development in
the long run. Nepal holds one of the highest hydropower potentials globally, with an estimated capacity of 83,000
MW, of which 42,000 are economically viable. Installing this vast capacity will be a long-term game, requiring sus-
tained investment, supportive policies, and a rules-based regional power trade market. The increased availability
of green electricity could reshape the comparative advantage of the economy and boost growth in the long-term.
Failure to expand hydropower production, however, could undermine the country’s growth prospect.

The development of Nepal’s hydropower sector could boost productivity across industries by providing reli-
able, low-cost, green electricity. Firms face high operational costs due to frequent power outages and reliance on
expensive alternatives like diesel generators. A steady supply of hydroelectricity would streamline operations, reduce
costs, and enable investment in energy-dependent technologies, improving production efficiency. Labor productivity
would also benefit, as consistent electricity would minimize workflow disruptions and support the use of advanced
tools. Moreover, clean energy could improve air quality, leading to healthier workers and fewer sick days, enhancing
overall workforce efficiency.

Hydropower could also stimulate the domestic production of goods, particularly in energy-intensive sectors
like manufacturing, agro-processing, and technology. With access to affordable and stable electricity, indus-
tries could scale up operations, improve quality control, and meet higher demand. The availability of cheap and
green energy would attract additional domestic and foreign investors looking to capitalize on low energy costs. This
shift could also reduce Nepal’s dependence on imported energy-intensive products, bolstering the local economy.
Branding Nepal’s goods and services as green and sustainable could further increase their competitiveness in global
markets, especially as demand for eco-friendly products rises.

Among services, the tourism sector stands to gain substantially from the expansion of hydropower. Reliable
green electricity would enable the development of modern tourist amenities, attracting higher-income and eco-con-
scious travelers. By positioning itself as a sustainable tourism destination, Nepal could capitalize on the growing global
trend toward environmentally friendly travel. This would not only improve the country’s tourism infrastructure but also
promote activities like eco-trekking and wildlife conservation. As green tourism gains popularity, hydropower could
play a key role in transforming Nepal into a leader in sustainable travel, boosting both the tourism and service sectors.

Tourism would also offer a path to growth with significantly higher employment benefits than hydropower
itself. The tourism sector is labor-intensive, creating jobs across various skill levels, from guides and hospitality staff
to artisans and transportation providers. Investments in tourism infrastructure not only enhance visitor experi-
ences but also directly benefit local communities by generating employment and fostering entrepreneurship. Unlike
hydropower, which primarily requires labor during the construction phase and offers limited jobs once operational,
tourism sustains ongoing employment opportunities. Hydropower could be leveraged to boost the tourism sector
by providing reliable green energy.

In addition to domestic benefits, more hydropower could be exported to neighboring countries. Several studies
by the World Bank and the Asian Development Bank suggest that hydropower exports to neighboring countries
Bangladesh and India would increase GDP and government revenues. Furthermore, there is potential for Nepal to
enter the green hydrogen market, though significant investments in infrastructure and international agreements
would be required to make this a viable option. Challenges like competition from China and India, as well as the need
for efficient transport routes, would need to be addressed for Nepal to capitalize on these opportunities.

But while hydropower holds great promise, unlocking the benefits will be a long-term endeavor. Hydropower
projects are complex and require significant time for planning, construction, and implementation. Additional delays



XVI I Nepal Country Economic Memorandum
from bureaucratic hurdles, environmental concerns, or logistical challenges can extend timelines even further. The
long-term nature of hydropower means that economic gains may take many years to fully materialize. Therefore,
while hydropower is a strategic asset for future growth, it should be part of a diversified development approach that
includes industries capable of providing more immediate growth and employment benefits, such as tourism.


Hydropower resources have not been exploited and electricity remains underutilized domestically
Despite its potential, hydropower remains vastly underutilized and domestic energy production is dominated
by biomass. Nepal has so far harnessed only 4 percent of its hydropower resources, with an installed capacity of
around 3,000 MW as of 2024. This underutilization is stark compared to regional peers like Pakistan and India,
which have exploited 17 percent and 29 percent of their potential, respectively. While hydropower has been the
near-exclusive source of electricity production, hydro-powered electricity accounts for a small fraction of Nepal’s
total energy production. Biofuels and waste, such as fuelwood and agricultural residues, made up more than 90
percent of the domestically produced energy in 2022.

The reliability of electricity supply remains a significant operational challenge for Nepali firms, despite the
elimination of scheduled load shedding in 2018. Frequent power outages continue to affect operations, with 76
percent of firms experiencing regular power cuts. This unreliable supply has had a substantial impact on firms’ output
and profitability, with over 13 percent of firms reporting losses exceeding 10 percent of their annual sales due to power
cuts in 2022. The weak distribution network, characterized by outdated and undercapacity transformers, exacerbates
these issues. As a coping mechanism, many firms rely on captive generators, with 36 percent using them in 2022.

Recent increases in hydropower capacity were driven by the private sector and give reason for a more opti-
mistic outlook. Total installed capacity has tripled over the past decade, reaching 2,990 MW by the end of 2024.
Larger projects like the Upper Tamakoshi plant have boosted capacity significantly, reducing net imports and in-
creasing exports to India. These improvements were largely driven by independent power producers (IPPs), which
accounted for over 70 percent of the capacity added since 2018. The share of IPPs in total installed hydropower
capacity increased accordingly, to 64 percent in 2024.


Expanding hydropower requires active policy intervention
Despite these advancements, expanding hydropower production will require overcoming key bottlenecks to
its development. The government defined the ambitious target of increasing installed hydropower capacity to
28,500 MW by 2035. The current roughly 10,000 MW portfolio of projects, however, falls short of these ambitions.
Expanding the project pipeline will require attracting additional financing, improving the market structure, imple-
menting supportive policies, improving infrastructure, and stimulating domestic electricity demand.

Achieving the government’s hydropower capacity target will require significant public and private invest-
ments. The public sector has invested in hydropower generation, transmission, and distribution through the Nepal
Electricity Authority (NEA) and its subsidiaries, leveraging resources from institutional investors. The private sector,
who accounted for the bulk of investment since 2018, has increasingly relied on the capital market to finance its
investment in electricity generation. Bond financing, due to the early development stage of the market, and foreign
investment in the sector have been limited. Inefficient public investment management has negatively affected the
financial viability of hydropower projects, which take substantially longer to finish than in other countries.

Mobilizing the additionally required funds will require a strengthened financing model for the sector. Nepal
needs to develop a clear strategy for financing the expansion of the sector, which could include the use of multilat-
eral guarantees to maximize the financing envelope, a roadmap for developing the domestic bond market, and an
effective framework for large-scale public-private partnerships (PPPs). Increasing foreign currency investment limits
and providing effective currency risk mitigation tools could attract more foreign investment.




                                                                      Nepal Country Economic Memorandum I XVII
NEA’s role as the sole buyer and distributor of electricity domestically and cross-border has limited the de-
velopment of the market. The viability of power purchase agreements (PPAs) with NEA hinges on take-or-pay
clauses that guarantee a minimum purchase of electricity, ensuring financial institutions are willing to fund projects.
However, NEA has been reluctant to adopt these clauses, due to concerns over surplus electricity during low demand
periods, leading to a cautious, selective approach to new agreements. This discretion creates delays for power pro-
ducers and hampers the overall growth of Nepal’s energy sector.

Compounding these challenges is Nepal’s outdated legal framework. The Electricity Act of 1992 fails to address
contemporary needs for hydropower development and energy trading. The stalled replacement legislation leaves
critical issues, such as tariff setting and private sector protections, unresolved, deterring private investment in gen-
eration and making transmission and distribution investments legally unfeasible. Policy instability and bureaucratic
inefficiencies within the Investment Board Nepal (IBN) further inhibit effective project facilitation, resulting in lengthy
approval processes and unclear regulations, thereby undermining investor confidence. Additionally, Nepal’s first-
come first-serve licensing regime has led to an inefficient allocation of resources and project delays.

Geopolitical factors also constrain Nepal’s ability to expand electricity exports to India and Bangladesh. Al-
though India currently imports around 900 MW from Nepal and expresses interest in increasing this, its 2018 guide-
lines restrict imports from projects financed by third-country investors, complicating long-term agreements. Nepal
faces challenges in securing stable PPAs with India due to fluctuating political relations and a slow approval process
for cross-border trade, which hinders the development of a more robust regional energy market and prevents Nepal
from fully capitalizing on its hydropower potential.

Nepal should strengthen the regulatory framework and policies to improve the structure of the electricity
market. The pending update to the Electricity Act must be enacted swiftly and the remaining legislation harmo-
nized. Streamlining the current licensing process would allow to prioritize project readiness and capacity and could
help attract more investment. To upgrade Nepal’s electricity grid, authorities must eliminate legal and bureaucratic
hurdles that hinder IPP investment in electricity transmission and distribution. IPPs should be legally permitted to
invest in electricity transmission and distribution.

Hydropower development faces additional headwind from low domestic electricity demand from firms and
households. Electricity has been underused by manufacturing firms, which consume significantly less electricity than
those in peer countries. Similarly, Nepal’s services sector continues to rely on biofuels rather than electricity. House-
holds have increasingly used electricity for lighting, but biofuels dominate their total energy use. Government could
stimulate domestic electricity demand by removing subsidies for fossil fuels, by revising electricity tariffs for house-
holds, and by providing incentives for firms to switch from fossil fuel-powered generators to electric alternatives.

Nepal’s weak transmission and distribution infrastructure requires additional investment and technological
upgrades. The existing infrastructure is often outdated and poorly maintained, resulting in frequent power outages
and inefficiencies in energy delivery, with system losses reported at 12.7 percent in 2024. This unreliability not only
disrupts the supply but also deters potential investments in the energy sector. Additionally, essential infrastructure
like access roads and transportation facilities for hydropower development is lacking, which complicates the trans-
portation of equipment to remote sites and leads to project delays and increased costs. Exports are limited by the
insufficient capacity of current cross-border lines.

Moreover, Nepal’s vulnerability to natural disasters poses a significant risk to hydropower projects. The 2015
earthquake and frequent floods have damaged numerous operational facilities. The dominance of run-of-river hy-
dropower plants, which account for over 90 percent of the total capacity, makes electricity production highly sea-
sonal and susceptible to fluctuations in water flow, further complicating the country’s energy stability and develop-
ment potential.




XVIII I Nepal Country Economic Memorandum
Addressing these challenges and developing the sector requires long-term policy commitment. Frequent
changes in political leadership and the resulting policy instability have undermined the more rapid development of
the hydropower sector. Unlocking the potential of the sector over the long-term will require clear policy and legal
guidance, and an institutional framework that facilitates increased private sector investment.


Boosting long-term growth and jobs through digitalization
Digitalization would improve productivity and create domestic jobs
Digital technologies can enhance economic growth by improving firm productivity. By facilitating the efficient
gathering, analysis, and transmission of data, digital technologies such as the internet, computers, and mobile
phones help reduce various economic costs. This leads to improved profitability, economic inclusion, and overall busi-
ness efficiency. During the COVID-19 pandemic, firms that invested in digital solutions or adopted online platforms
saw notable increases in digital sales. Firms that adopted digital technologies also demonstrated significantly higher
labor productivity than non-adopters, as these technologies allow for the automation of routine and repetitive tasks.

Digital technologies could also create much needed jobs in Nepal. By reducing transaction costs and fostering
entrepreneurship, digital platforms create new employment opportunities, both directly and indirectly. Examples
such as Daraz Nepal, which saw its registered sellers grow from 2,500 to 20,000 in five years, and Foodmandu,
which expanded its workforce to 450 employees, demonstrate the transformative impact of digital platforms on job
creation. Additionally, Nepal’s low-wage structure and English-speaking workforce make it an attractive destination
for Business Process Outsourcing (BPO).


The ICT sector remains small, but its dynamics are promising
Nepal’s private sector has shown a growing commitment to investing in the ICT sector. Between 2017 and
2023 the private sector contributed NPR 7.1 billion across 109 industries. This investment has led to the creation of
6,746 jobs, demonstrating the sector’s capacity to generate employment. The scope of investments spans small-
scale enterprises with fixed capital below NPR 150 million to large corporations exceeding NPR 500 million in capital.
This diversity reflects the multifaceted nature of the ICT sector in Nepal, covering various industries from telecom-
munications to IT services.

Despite its relatively small size, the ICT sector has steadily contributed to economic growth, particularly ICT
service exports. The digital sector, although encompassing a broad range of goods and services, is defined in this
report as ICT services and manufacturing. As of 2022, ICT accounted for only 1.7 percent of nominal GDP yet has
contributed an average 0.3 percentage points to economic growth over the past decade. The private sector was
responsible for almost 80 percent of the sector’s value added. ICT services have consistently contributed to export
revenues, accounting for 10 percent of Nepal’s total service exports or 0.3 percent of GDP over the past six years.
This positions Nepal competitively within the region, trailing only Pakistan in terms of ICT service exports as a per-
centage of GDP. Digitally delivered services exports achieved an impressive compound annual growth rate of 11.6
percent, compared to the 5.8 percent growth rate for non-digital services exports.

Despite the promising growth of ICT services, Nepal faces significant challenges in producing and exporting
ICT goods. The low levels of FDI in the sector have limited firms’ ability to compete in the global market, as they
struggle to integrate into global value chains dominated by multinational corporations. Unlike countries such as
China and Viet Nam, which have successfully attracted FDI to build robust ICT goods manufacturing industries,
Nepal’s exports of ICT goods remain minimal. Imports of ICT goods, on the other hand, account for 4 percent of the
country’s total merchandise imports, with communication equipment like mobile phones and computers comprising
the bulk of these imports.




                                                                     Nepal Country Economic Memorandum I XIX
Nepal’s ICT labor force has grown faster than overall employment but remains small. The sector’s workforce
expanded at a compound annual growth rate of 5.1 percent between 2011-2021, outpacing the overall labor force
growth rate. However, the ICT labor force remains small, representing just 0.35 percent of the total workforce in
2021. Gender disparities persist within the sector, with women accounting for a smaller proportion of the ICT work-
force than men, though the number of economically active women has been growing at a faster rate.


Nepal’s digital infrastructure has improved, but a fixed broadband internet coverage gap persists
One of the critical challenges Nepal faces in expanding digital adoption is the substantial gap in fixed broad-
band internet coverage. The country’s landlocked geography limits direct access to global submarine cables, es-
sential for high-speed and reliable internet connectivity. As a result, Nepal relies heavily on India and China for inter-
national bandwidth, which incurs additional costs and subjects the country to the telecommunications regulations
of its neighbors. Nearly half of Nepal’s population lives more than 10 kilometers away from fiber-optic infrastructure.
While the government has initiated efforts to address this gap through the Rural Telecommunication Development
Fund (RTDF), delays due to legal disputes have hindered timely implementation.

Nepal is making notable strides in developing data infrastructure. The establishment of the Nepal Internet
Exchange (NIXP) has improved the affordability and quality of internet services by enabling local data exchanges,
reducing reliance on international transit providers. With a higher-than-average number of members compared
to other South Asian IXPs, NIXP helps lower overall data transit costs, making internet access more affordable for
users. Nepal’s above average density of colocation data centers provides shared infrastructure that improves oper-
ational efficiency and reduces costs for businesses.

Nepal’s commitment to developing a robust Digital Public Infrastructure (DPI) is also noteworthy. While still in
its early stages, DPI aims to create a secure, interconnected network that ensures equal access to both public and
private services. Recent initiatives highlight Nepal’s progress in building its DPI ecosystem. The National ID program
and the Nagarik Mobile App are key examples of this commitment. Launched in 2021, the Nagarik App has gained
over 800,000 users and provides access to services from more than 30 government bodies.

As Nepal continues to invest in its digital infrastructure, the potential for transformation in various sectors,
including commerce, public services, and individual welfare, is significant. Strengthening both hard and soft
infrastructure will be essential in realizing this potential, fostering an environment conducive to innovation and
attracting further investment. The ongoing development in the digital landscape indicates a promising future for
Nepal’s economy, positioning it as a competitive player in the regional and global ICT sectors.


Digital payment adoption among firms and households lags peer countries
Most formal firms in Nepal had access to high-speed fixed broadband internet in 2023. Internet usage was
more common in the services sector than in manufacturing. Despite high internet penetration, only about half of
formal firms had an online presence, highlighting significant room for improvement. Firms nevertheless appear to
increasingly recognize the importance of online presence for sales and customer interaction, evidenced by strong
growth in website adoption since 2013.

Digital payment adoption remains low, especially in manufacturing. Only 10 percent of manufacturing firms
used electronic payments in 2023. Larger firms were more likely to make digital payments but faced higher trans-
action costs, while medium-sized firms received a higher percentage of their sales through digital channels. The
use of ICT capital in the manufacturing sector also lags, with only a modest rise in tangible ICT capital per worker
between 2011 and 2019. Despite some improvements in digital technology adoption during the COVID-19 pandemic,
the overall use of digital technologies and capital remains low, especially in manufacturing.




XX I Nepal Country Economic Memorandum
Digital technology adoption among households has grown, but gaps remain. Internet usage rose from 3.3 per-
cent in 2011 to 38 percent in 2021, while mobile phone and computer ownership also increased. However, computer
adoption is still low at just 15 percent. Despite near-universal mobile broadband coverage, 3G and 4G penetration
remains limited. Large differences in usage across provinces and across households persist, with wealthier, urban,
and more educated households adopting digital technologies faster. Gender gaps are also significant, particularly in
the use of computers.

Digital payment adoption among households has also risen but lags Nepal’s lower-middle-income (LMIC)
peers. The share of adults using digital payments climbed from 10 percent in 2014 to 28.6 percent in 2021, yet
lower than the averages for South Asia and other comparable economies. The COVID-19 pandemic accelerated the
use of digital payments, with nearly 1.5 million adults starting to use digital transactions. Urban areas saw a more
substantial increase in digital payment usage compared to rural regions. Significant gender, age, and income dispar-
ities limit broader financial inclusion.


Digital technologies remain expensive
Fixed broadband internet remains expensive in Nepal, in contrast to mobile broadband. While mobile broad-
band prices have significantly decreased, now accounting for 2.14 percent of average GNI per capita, fixed broadband
remains costly at 7.8 percent of GNI. This disparity is partly due to heavy taxation in the ICT sector that burden
service providers and are ultimately passed on to consumers. The affordability of entry-level smartphones has
worsened, with prices now consuming 33 percent average of monthly income, primarily due to high tax rates that
far exceed those of neighboring countries.

For businesses, the high annual cost of internet services poses a significant challenge, especially for smaller
firms. Frequent internet outages exacerbate these issues, affecting over 30 percent of firms in 2022, leading to an
average downtime of 3.5 hours and a 2.1 percent annual sales loss. The impact of these outages varies by firm size
and sector, with larger firms experiencing shorter disruptions but facing more significant revenue declines, while
smaller firms endure longer downtimes and greater financial repercussions.


The market is poorly regulated and highly concentrated
Nepal’s regulatory environment is weaker than in other LMICs and has not improved over the past decade.
The Telecommunications Act of 1997, is outdated, reflecting a time before the digital revolution and the proliferation
of data-based communications. The Nepal Telecommunication Authority (NTA) lacks the independence necessary
for effective regulation since its members are appointed by the Ministry of Communication and Information Technol-
ogy, creating potential conflicts of interest. As a result, Nepal’s regulatory framework lags other LMICs, as reflected
by its low ICT Regulatory Tracker score, and has not improved in the past 15 years, while most LMICs have advanced.

Nepal’s telecom market suffers from a lack of competition, especially in mobile broadband, which is dominated
by two major players. This concentration limits innovation and service expansion, negatively affecting consumers
through higher prices and lower service quality. In response, the NTA is working to introduce a third mobile operator
and has also eliminated the minimum threshold for FDI in the ICT sector. However, the regulatory regime remains
weak due to inadequate infrastructure sharing and the absence of secondary spectrum trading, which could other-
wise foster more competition and efficient resource use. While Nepal has introduced regulations to promote infra-
structure sharing, enforcement remains a challenge, and the 2023 spectrum policy does not allow spectrum trading.

Updating the Telecommunications Act and the digital strategy would strengthen the regulation of the sector.
The revised act should transition to data-centric services and address issues around cybersecurity, data protection,
and ethical artificial intelligence. The legal framework should also enable the leasing and secondary trading of spec-
trum and enforce infrastructure sharing. The creation of a dedicated competition authority and strengthening NTA
would foster competition.



                                                                     Nepal Country Economic Memorandum I XXI
Digital skills are critically low
Nepal needs to address a significant digital skills gap, which hampers its ability to unlock technological po-
tential and drive digitalization. According to Wiley’s Digital Skill Gap Index, Nepal ranks 124th out of 134 econo-
mies, performing poorly in key areas such as information literacy, communication, and digital content creation. The
lack of basic digital skills is stark and low digital literacy rates severely limit Nepal’s workforce’s ability to engage
with modern technology. Digital skills could be improved by integrating them into school curricula and through train-
ing programs for different age groups and demographics.

Finally, the adoption of key digital public infrastructure has been delayed. Digital identities (IDs) and digital sig-
natures have been implemented slowly, hindered by factors such as non-mandatory use and a focus on physical IDs.
Despite 15 million digital ID registrations, access issues have limited their use, though a government mandate start-
ing in 2025 may boost adoption. Similarly, digital signatures, legally recognized since 2006, remain underutilized,
with institutions like banks still relying on physical signatures. Security concerns, like data breaches, have eroded
public trust in digital payments, leading to an increased reliance on paper-based transactions, a trend contrary to
other South Asian nations’ digital payment growth.

Nepal has officially declared 2024-2034 the Information Technology Decade, but substantial effort will be
required to turn this vision into reality. Key initiatives in the past, such as establishing the internet as an essential
service, have not delivered anticipated results. To adapt and take advantage of the rapidly evolving digital landscape
will require a multifaceted approach that improves the regulatory environment, accelerates then development of
digital public infrastructure, reforms the RTDF, expands skills, and promotes advanced and affordable technologies.


The way forward
Nepal’s current growth model, heavily reliant on remittances and consumption, has proven resilient but in-
sufficient to meet the country’s ambitious development targets. While remittances have buoyed private con-
sumption and reduced poverty, they have not translated into substantial job creation or productivity gains across
key economic sectors. This model, coupled with structural limitations such as low export competitiveness, limited in-
dustrial output, and dependency on informal labor, constrains Nepal’s potential to achieve sustained, higher growth
rates. To break this cycle and enhance growth, significant reforms are essential to shift the economy toward more
dynamic and sustainable drivers of growth.

Significant policy reforms are imperative to shift the economy toward more dynamic and sustainable drivers
of growth. The main objective of this report is to provide policy guidance for Nepal to achieve strong and sustained
long-term growth. Chapter 1 provides a detailed discussion of the factors supporting and limiting economic growth.
The following chapters each offer granular policy recommendations on how to unlock the potential of sectors that
could boost long-term growth. The necessary reforms are summarized as follows:




XXII I Nepal Country Economic Memorandum
Table ES1. Policy recommendations to improve migration outcomes

                           POLICY RECOMMENDATIONS – GETTING MORE OUT OF MIGRATION

                     Recommendation                        Fiscal               Recommendation                     Fiscal
                                                          Impact                                                  Impact

                                                       Creating Opportunities
         Expand formal bilateral labor arrangements                Improve monitoring and implementation           
         and increase awareness of existing ones.           Low     of formal labor arrangements and provide       Low
                                                                    effective consular support.
Tier 1




         Include better provisions for worker pro-                 Lower the cost of sending remittances.          
         tection and improvement in labor market            Low                                                    Low
         outcomes while abroad in formal bilateral
         arrangements.
         Expand affordable financing and infor-                    Improve data on returnees and evidence of       
Tier 2




         mation about destination markets and               Low     existing policy interventions.                 Low
         domestic exit processes in lagging areas
         and among the less well-off.
                                                        Creating Capabilities
         Enhance pre-departure training without                    Understand destination economies and            
Tier 1




         increasing the cost burden to improve              Low     enable reskilling per demand.                  Low
         migrants’ preparedness.


Table ES2. Policy recommendations to boost exports

                                   POLICY RECOMMENDATIONS – BOOSTING EXPORTS

                     Recommendation                        Fiscal               Recommendation                     Fiscal
                                                          Impact                                                  Impact

                                                       Creating Opportunities
         Improve market competition in key                         Develop and promote remittance-linked           
         non-tradable sectors.                              Low     financial instruments for productive in-       Low
                                                                    vestment and household savings.
         Substantially revise or eliminate the Cash         Gen-  Strengthen trade diplomacy and invest-            
         Incentive Scheme for Exporters (CISE).            erates ment promotion by leveraging diplomatic          Low
                                                          Revenue missions.
Tier 1




         Improve trade and quality infrastructure.           
                                                            Low
         Revise the current input duty drawback                    Develop a strategy to gradually compress        
         systems, particularly from small exporters.       High     and rationalize input tariffs and com-         High
                                                                    pensate revenue loss with less distorting
                                                                    instruments.
         Sharpen the monetary policy framework            Indirect Initiate a dialogue about the suitability of   Indirect
         with a view of containing inflation.             Effects the current peg.                                Effects
Tier 2




         Develop a strategy to replace excise taxes         
         designed as de-facto tariffs with less dis-       High
         torting instruments.




                                                                         Nepal Country Economic Memorandum I XXIII
Table ES3. Policy recommendations to boost hydropower development
                                  POLICY RECOMMENDATIONS - BOOSTING HYDROPOWER

                      Recommendation                      Fiscal               Recommendation                  Fiscal
                                                         Impact                                               Impact

                                                      Creating Opportunities
         Strengthen the regulatory framework and                  Reduce bureaucratic hurdles for the pri-     
         harmonize policies.                               Low     vate sector.                                Low
Tier 1




         Strengthen the financing model for hydro-                Invest in transmission and distribution      
         power projects.                                   Low     infrastructure.                             High
         Stimulate domestic electricity demand.             
Tier 2




                                                           Low

                                                      Creating Capabilities
         Enhance the capacity of key hydropower             
Tier 1




         stakeholders.                                     Low



Table ES4. Policy recommendations to boost digitalization

                              POLICY RECOMMENDATIONS – BOOSTING THE DIGITAL SECTOR

                      Recommendation                      Fiscal               Recommendation                  Fiscal
                                                         Impact                                               Impact

                                                   Creating Opportunities
         Improve the regulatory environment.                      Accelerate the development of digital        
                                                           Low     public infrastructure.                      Low
Tier 1




         Reform the RTDF.                                   
                                                           Low
         Make digital technologies more affordable.               Promote the transition to advanced net-      
Tier 2




                                                           Low     works and technologies.                     High

                                                      Creating Capabilities
         Expand digital skills.                             
Tier 1




                                                           Low




XXIV I Nepal Country Economic Memorandum
CHAPTER 1.
Facts of Growth
Nepal’s economic growth from 1996 to 2023 lagged peer countries but demonstrated resilience in the face of
persistent challenges. The country navigated a decade-long conflict, political instability, and multiple external
shocks, including the 2015 earthquake, India’s blockade, and the COVID-19 pandemic. Despite these obstacles,
the economy grew at an average real rate of 4.2 percent, though this remained slower than the growth achieved
by its peer countries.

Remarkably, even with slower growth, Nepal achieved a significant reduction in poverty. Living standards im-
proved broadly, and extreme poverty fell from over 50 percent in 1996 to just 0.4 percent in 2023, an achieve-
ment unmatched by many peers. This success was largely fueled by remittances from the increasing number of
migrant workers, which underscores both a strength and a structural weakness of the economy.

While remittances bolstered household incomes and consumption, Nepal’s economic development has been
constrained by insufficient job creation and underperformance in key sectors such as manufacturing and tour-
ism. Investment, though rising after the 2015 earthquake, was largely directed at reconstruction rather than
growth-enhancing industries. Meanwhile, stagnant exports and a widening trade deficit have limited Nepal’s
ability to compete globally and achieve more dynamic, sustainable growth.

Nepal’s labor market has struggled to create enough jobs to keep pace with its growing working-age population,
resulting in a declining employment ratio over the past two decades. Most of the jobs created were in the in-
formal sector, particularly in agriculture, where productivity remains low. Labor productivity in Nepal lags peer
countries, especially in industry and agriculture, where output per worker is significantly lower. This lack of for-
mal, high-productivity jobs has constrained overall economic growth, limiting the country’s ability to transition
into higher-value sectors and achieve faster development.

Despite these challenges, Nepal holds significant growth potential in sectors like hydropower and information
and communications technology (ICT). Hydropower, with its abundant resources, could provide a reliable source
of clean energy and boost exports, helping to reduce dependence on fossil fuels and imported energy. ICT ser-
vices, though still small, have shown promise in driving export-led growth, positioning Nepal competitively in
South Asia. However, inadequate infrastructure and insufficient policies have slowed progress in these high-po-
tential areas.

Looking ahead, Nepal’s ambitious growth targets require substantial reforms. Enhancing productivity, improving
export competitiveness, and attracting foreign direct investment are crucial to achieving higher growth rates.
The country must also address its vulnerabilities to external shocks, such as climate change and the global econ-
omy, to ensure sustainable development. By capitalizing on its hydropower and ICT sectors, and by implement-
ing structural reforms, Nepal can gradually move toward stronger and more resilient economic growth.




                                                                      Nepal Country Economic Memorandum I 1
1.1.	 Nepal’s journey to lower-middle income status
The discussion of Nepal’s economic performance comprises three distinct development periods, each shaped
by unique challenges and events. The first was the conflict period, from 1996-20061, marked by a decade long
armed conflict between the government of Nepal and the Communist (Maoist) Party of Nepal and cost the lives of
over 13,000 people (Phadera 2019). The second period, from 2007–2014, followed the signing of a peace treaty and
was characterized by the abolishment of the monarchy, political instability, and a further increase in the outward
migration of Nepalese workers.2 The third period, from 2015–2023, was market by repeated shocks, including the
devastating 2015 Gorkha earthquakes, India’s 2015/2016 blockade, the 2017 landslide, and the 2020 COVID-19
pandemic, as well as the continuation of high government turnover. The third period also saw the adoption of the
new Constitution in September 2015, which established Nepal as a federal democratic republic with three tiers of
government, local, provincial, and federal.

Nepal’s growth performance is benchmarked to a set of structural and aspirational peer countries. Structural
peer countries are selected based on economic characteristics that very closely resemble those of Nepal, i.e., low-
er-middle income (LMIC) status, geography, high level of hydropower potential, high dependence on a single trading
partner, strong international remittance inflows, and high vulnerability to climate change. Structural peer countries
include Bangladesh, Bolivia, and Kyrgyz Republic. Aspirational peer countries include Cambodia, Lao People’s Dem-
ocratic Republic (PDR), and Moldova, and are selected based on the same criteria but have achieved higher income
levels than Nepal and its structural peers.

Nepal’s economy has shown remarkable resilience amid various shocks, yet its growth still lagged that of
peer countries. From 1996–2023, real GDP expanded by an average 4.2 percent annually, a remarkable rate con-
sidering the domestic conflict and multiple external shocks affecting the country. The main reason behind the ro-
bustness of growth were remittances from migrant workers, which are among the highest worldwide relative to the
country’s GDP, and enabled robust private domestic consumption, boosting the services sector. Nepal’s average
growth rate nevertheless fell short of the rates observed in peer countries. Within South Asia, Nepal’s average
growth rate ranked sixth out of eight countries, surpassing only Pakistan and Sri Lanka.3 In comparison to struc-
tural and aspirational peers, Nepal was outperformed by both groups, with only Bolivia and Moldova recording lower
average growth rates among peer countries.

Nepal’s real GDP growth underperformed compared to peer countries during the conflict and the post-con-
flict periods (Figure 1.1). During the armed conflict period, Nepal recorded average annual real GDP growth of 4
percent, below the 4.4 percent achieved by structural peers and significantly below the 5.9 percent of aspirational
peers. During the post-conflict period, average growth increased marginally to 4.6 percent, yet again substantially
falling short of peer countries. The absence of a larger peace dividend was mainly due to political economy factors
and policy instability, which hampered reform efforts and delayed the adoption of the new Constitution. Increasing
remittances from Nepalese workers that left the country during the conflict and post-conflict periods provided a
buffer against domestic economic weaknesses and contributed significantly to the resilience of the economy.

During the period of repeated shocks, Nepal’s growth performance was on par with peer countries. From
2015–2023, Nepal managed to sustain an average annual real GDP growth rate of 4.2 percent, ranking fourth out of
eight countries in South Asia. Nepal’s average growth slightly outpaced that of its s aspirational peer countries and
was roughly on par with structural peers. However, despite the country’s resilience in confronting numerous shocks,
Nepal’s performance versus structural peers is influenced by Bolivia’s large recession in 2020. When discounting the
pandemic year, Nepal’s performance was weaker than that of structural peers.

Nepal’s overall lower growth rate resulted in a widening real output gap compared to peer countries (Figure
1.2). Nepal’s real GDP tripled between 1996 and 2023. Over the same time, real output levels in structural and aspi-
rational peers increased 3.5 and 4.5 times, respectively. The gap widened particularly fast in the post-conflict period
and continued to grow during the repeated shocks period.



2 I Nepal Country Economic Memorandum
Figure 1.1. Nepal’s economy grew slower than peers’                                                                    Figure 1.2. … the real output gap nevertheless
before 2014 and in line thereafter…                                                                                    widened compared to peers.

                           7                                                                                                                       500
                           6                                                                                                                       400




                                                                                                                         l GDP Ind x
GDP Growth (%)




                                                                                                                       (1996 = 100)
                           5
        R l




                           4                                                                                                                       300
                           3                                                                                                                       200
 Av r




                           2
                                                                                                                                                   100




                                                                                                                       R
                           1
                           0                                                                                                                        0
                                     Conflict                   Post-Conflict                   R p t d




                                                                                                                                                                                      2005
                                                                                                                                                                          2002




                                                                                                                                                                                                                                  2020
                                                                                                                                                         1996

                                                                                                                                                                 1999




                                                                                                                                                                                              2008




                                                                                                                                                                                                                                           2023
                                                                                                                                                                                                                          2017
                                                                                                                                                                                                               2014
                                                                                                                                                                                                       2011
                                   1996-2006                    2007-2014                      Shocks
                                                                                             2015-2023
                                          N p l            Structur l                Aspir tion l                                                               N p l                 Structur l                    Aspir tion l

Source: World Development Indicators (WDI) October 2024 and                                                            Source: WDI October 2024 and World Bank staff calculations.
World Bank staff calculations.	



Nepal’s income level has grown more rapidly than that of its structural peers, supported by slow population
growth. Since 1996, Nepal’s GNI per capita increased by an average of 7.3 percent annually, outpacing structural
peers, which grew at 6.3 percent per year, but falling behind aspirational peers, who averaged 8.3 percent growth.4
Nepal’s GNI per capita increased fastest during the post-conflict period, which was marked by a substantial increase
in outward migration. Strong per capita growth was bolstered by Nepal’s relatively slow population growth rate of
1.2 percent annually. The declining proportion of dependents (those younger than 15 or older than 64) relative to the
working-age population, have created the conditions for a demographic dividend, which presents a key opportunity
for further accelerating economic growth as the country capitalizes on its increasingly productive workforce.


Figure 1.3. GNI per capita lost ground against                                                                         Figure 1.4. … and current growth rates are not
peers…	                                                                                                                sufficient to catch up in the long-term

                           4000
GNI/C pit , Atl s M thod




                                                                                                                                                   20000
                                                                                                                       GNI/Capita, Atlast Method




                           3000                                                                                                                    15000
     (curr nt US$)




                                                                                                                            (current US$)




                           2000                                                                                                                    10000

                           1000                                                                                                                     5000

                               0                                                                                                                          0
                                                                                           2014
                                                 1996
                                                        1999


                                                                      2005




                                                                                                  2017


                                                                                                                2023
                                                               2002




                                                                                                         2020
                                          1993




                                                                             2008
                                   1990




                                                                                    2011




                                                                                                                                                                                                                                        2043
                                                                                                                                                                 2023
                                                                                                                                                                        2025




                                                                                                                                                                                                                   2037
                                                                                                                                                                                                                          2039
                                                                                                                                                                               2027


                                                                                                                                                                                              2031
                                                                                                                                                                                       2029


                                                                                                                                                                                                     2033
                                                                                                                                                                                                            2035




                                                                                                                                                                                                                                 2041




                                            N p l                               Structur l                                                                                Nepal                                    Structural
                                            Aspir tion l                        LMIC Thr shold                                                                            Aspirational                             UMIC Threshold


Source: WDI October 2024 and World Bank staff calculations.                                                            Source: WDI October 2024 and World Bank staff calculations.


                                                                                                                       	

                                                                                                                       	




                                                                                                                                                         Nepal Country Economic Memorandum I 3
As a result, Nepal’s income level made some progress in catching up with structural peers, although it con-
tinues to fall behind aspirational peers (Figure 1.3). In 1996, Nepal’s GNI per capita stood at 39 percent of that of
structural peers, but stronger growth lifted it to 50 percent by 2023. The gap with aspirational peers widened, with
Nepal’s GNI per capita reaching only 40 percent of their level by 2023, down from 49 percent in 1996. Projections
based on historical averages indicate that Nepal is unlikely to catch up with either group of peers. If GNI per capita
and the upper-middle income threshold grow at their 1996-2023 average rates, Nepal would take approximately
two decades to reach upper-middle-income status, without closing the income gap with structural or aspirational
peers over that period (Figure 1.4).

Nepal is highly vulnerable to climate change and natural disasters, as evidenced by the period of repeated
shocks. Nepal ranks as the 10th most affected country in the world according to the Climate Risk Index5 Nepal’s
vulnerability to climate events stems from a lack of resilient infrastructure together with fragile and mountainous
ecosystems, unplanned settlements, and an agriculture determined by monsoons. These characteristics put an
estimated 80 percent of the population at risk from natural and climate-induced hazards, including extreme heat,
flooding, and air pollution. The World Bank Nepal Country Climate and Development Report (CCDR, WB 2022) pro-
vides an extensive discussion of the macroeconomic effects of climate change and natural disasters.

The lack of domestic job opportunities has caused the significant outmigration of Nepalese workers over the
past decades. Between 1996 and 2023, authorities issued over 6.6 million new labor approvals to migrant workers.
The average outmigration of 237,127 workers per year has resulted in more than 7 percent of the total population
living abroad by 2023. Migration remains dominated by young male adults, with a median migrant age of 28 years
and a share of male migrants of more than two-thirds. The number of destinations has increased to around 150
countries, but most migrants are employed in the Gulf Cooperation Council (GCC) countries and Malaysia.6

Consequently, remittances were among the highest in the world relative to GDP, and the primary reason for
Nepal’s resilient growth in the face of many shocks. Remittances more than tripled from an average of 7 percent
of GDP between 1996–2006 to an average of nearly 25 percent of GDP between 2015–2023 (Figure 1.5). Per capita
remittances and the share of households receiving remittances increased for the poor and non-poor, but with larger
gains at the lower end of the distribution. This enabled robust private consumption, which has been the primary
source of growth.

Figure 1.5. Remittance inflows increased signifi-                            Figure 1.6. …and contributed to the poverty
cantly over time…                                                            reduction.	
                            30                                                                       60                                               100
   R mitt nc s (% of GDP)




                                                                               Popul tion Sh r (%)




                            25                                                                       50                                               80
                            20                                                                       40
                                                                                                                                                      60
                            15                                                                       30
                                                                                                                                                      40
                            10                                                                       20
                                                                                                     10                                               20
                             5
                            0                                                                        0                                                0
                                   Conflict     Post-Conflict       R p t d                                 2003            2010                2022
                                 1996-2006      2007-2014          Shocks                                  N p l                 N p l
                                                                 2015-2023                                 < 2.15$/d             < 6.85$/d    (rhs)
                                  N p l      Structur l       Aspir tion l                                 Structur l            Structur l
                                                                                                           < 2.15$/d             < 6.85$/d    (rhs)
Source: WDI October 2024 and World Bank staff calculations.                                                Aspir tion l          Aspir tion l
                                                                                                           < 2.15$/d             < 6.85$/d (rhs)
                                                                                                                                 R mitt nc s/GDP
                                                                             Source: National Statistics Office and World Bank staff calculations.



4 I Nepal Country Economic Memorandum
Remittances also directly contributed to the remarkable poverty reduction over the past decades. 30 years
ago, around 55 percent of Nepal’s population lived on less than US$ 2.15 per day, a substantially higher share than
in peer countries. By 2023, the situation has drastically changed, and Nepal has practically eradicated extreme
poverty with only 0.4 percent of Nepalese living on less than US$ 2.15 per day, a lower share than in peers (Figure
1.6). The same pattern holds true when looking at the poverty headcount ratio measured at US$ 6.85 per day,
which nearly halved over the past decades. Evidence of higher living standards is also supported by higher per capita
spending in urban and rural areas. Remittances have directly accounted for more than 30 percent of the poverty
reduction in Nepal between 2011 and 2023 (see chapter 3).

The migration of Nepali workers has strengthened household resilience to economic shocks, in addition to
reducing poverty. On average, migrant workers earn three times more than domestic earnings7, and an average
migrant worker with 9 years of education earns the same amount as a tertiary-educated domestic worker.8 In the
context of a high exposure to shocks and limited access to formal assistance, informal safety nets, or coping mech-
anisms, having a migrant worker abroad mitigates risks associated with negative income shocks. During COVID-19,
the correlation between the labor income shock and economic distress was small or close to zero for migrant house-
holds relative to non-migrant ones.9

Nepal’s progress in reducing poverty nevertheless remains vulnerable to economic and climate shocks, and
other uninsured risks.10 Nepal lacks targeted policy instruments for the poor. The fiscal model relies largely on pub-
lic infrastructure and service delivery for resource distribution. In 2023, Nepal’s public spending on social assistance
as a share of GDP was 1.6 percent, and categorically targeted programs accounted for almost all these expenditures.
While more than one third of the poorest 20 percent of the population now receive some social assistance, 85 per-
cent come from categorical programs that target the elderly, single women, or the disabled. The COVID-19 crisis
exposed the challenges of relying solely on categorical systems that have limited scalability and cannot be flexibly
reoriented to meet emerging needs during an emergency. Nepal’s was not able to activate a system of direct trans-
fers in response to the crisis, in part due to the lack of digital public infrastructure, which resulted in a minimal emer-
gency fiscal response, covering just 2 percent of households compared to the regional average of nearly 20 percent.

Nepal’s exports of labor and dependence on remittances, despite their positive contribution to reducing pov-
erty, also pose challenges for economic development. Migration was the people’s answer to the lack of jobs in the
weak domestic labor market. Remittances allowed for an increased per capita consumption and higher living stand-
ards. Peoples’ efforts, however, provided a buffer to domestic economic weaknesses and alleviated the pressure on
governments to make progress on economic development and poverty reduction, negatively affecting incentives to
implement critical economic policy and reforms. While there is currently no empirical evidence for it, migration could
also lead to a future brain drain, if higher-educated workers were to leave the country with the intention of living
abroad with their families.


1.2.	 Growth accounting and drivers
Understanding the contributing, driving, and restraining factors of economic growth requires an examina-
tion through several lenses. The expenditure approach measures aggregate demand in the economy, whether
short-term developments are consumption or investment driven, and assesses the economy’s external competitive-
ness through exports. The production approach accounts for each sector’s contribution to growth and the structural
changes the economy has undergone. Finally, the Solow-Swan long-term growth model assesses whether growth
has been driven by capital accumulation or labor and provides an estimate of total factor productivity.




                                                                          Nepal Country Economic Memorandum I 5
1.2.1.	Expenditure approach11

Private consumption has accounted for the largest share of real GDP growth on the expenditure side. It’s
contribution to real growth remained strong across all three periods and increased from an average 3.1 percentage
points during the conflict period to 3.6 percentage points during the repeated shocks period (Figure 1.7). The con-
tribution of public consumption was smaller and fell from 0.4 percentage points during the conflict period to 0.2
percentage points on average in the repeated shocks period. The share of private consumption in real GDP remained
high and reached 80 percent on average during the repeated shocks period (Figure 1.8). Overall consumption, public
and private, amounted to 89 percent of real GDP in 2023.

Figure 1.7. Private consumption has been the biggest contributor to growth in Nepal…
l Growth (PP)




                    10
                    8
                    6
                    4
                    2
Contribution to R




                    0
                    -2
                    -4
                                 Conflict




                                                Post-Conflict




                                                                      t d Shocks




                                                                                         Conflict




                                                                                                      Post-Conflict




                                                                                                                       t d Shocks




                                                                                                                                        Conflict




                                                                                                                                                       Post-Conflict




                                                                                                                                                                            t d Shocks
                                                                      2015-2023




                                                                                                                       2015-2023




                                                                                                                                                                            2015-2023
                              2002-2006




                                                                                      2002-2006




                                                                                                                                     2002-2006
                                                  2007-2014




                                                                                                        2007-2014




                                                                                                                                                         2007-2014
                                                                      R p




                                                                                                                       R p




                                                                                                                                                                            R p
                                                N p l                                                Structur l                                     Aspir tion l
                                Inv stm nt                          Public Consumption                 Priv t Consumption                         Exports                Imports
Source: WDI October 2024 and World Bank staff calculations.


Figure 1.8. ... and its share in GDP remained high over time.
                     200
    l GDP (%)




                     150
                     100
                         50
    Sh r in r




                         0
                     -50
                    -100
                                      Conflict




                                                     Post-Conflict




                                                                         t d Shocks




                                                                                           Conflict




                                                                                                        Post-Conflict




                                                                                                                        t d Shocks




                                                                                                                                        Conflict




                                                                                                                                                       Post-Conflict




                                                                                                                                                                           t d Shocks
                                   2001-2006




                                                                         2015-2023




                                                                                        2001-2006




                                                                                                                        2015-2023




                                                                                                                                     2001-2006




                                                                                                                                                                           2015-2023
                                                       2007-2014




                                                                                                          2007-2014




                                                                                                                                                         2007-2014
                                                                         R p




                                                                                                                        R p




                                                                                                                                                                           R p




                                                    N p l                                            Structur l                                     Aspir tion l

                                  GDP           Public Consumption                    Inv stm nt              Priv t Consumption              Exports                 Imports

Source: WDI October 2024 and World Bank staff calculations.




6 I Nepal Country Economic Memorandum
Nepal’s reliance on remittance-fueled consumption becomes apparent when comparing the country to its
peers.12 The surge in private consumption was enabled by increasing remittances from the large number of Nepa-
lis working abroad, which provided households with the means to maintain or increase consumption even during
economic shocks. In both structural and aspiration peer countries, the contribution of private consumption to real
growth was significantly lower and decreased over time, while exports contributed significantly in aspirational peers.

Growth was increasingly bolstered by investment spending, particularly in the period of repeated shocks.
The average contribution of investment to real GDP growth increased from 0.9 percentage points during the con-
flict period to 2.1 percentage points during the repeated shocks. The share of investment in real GDP consequently
increased to 34 percent on average during 2015-2023, higher than in structural and aspirational peers. Private in-
vestment drove the overall increase and accounted for 65 percent of overall investment by 2023.

The limited growth impact of higher investment levels may be due to their focus on post-disaster recon-
struction and replenishing fixed assets. Although investment has risen significantly and contributed to growth,
Nepal’s economic performance has still lagged that of its peers. This is primarily due to the use of investment for the
reconstruction in the aftermath of the earthquake, e.g., for residential housing. Another reason may be the increase
in hydropower investments, which require large upfront capital outlays but deliver returns over a longer time horizon.
This delay in realizing the economic benefits may partly explain why the expected growth from these investments
has not yet materialized.

Exports remain the biggest opportunity Nepal has missed to boost growth and create jobs. A thriving export
sector allows firms to increase production and revenue, as well as their productivity. Such expansion would likely
lead to firms creating new and higher quality jobs, facilitating the transition out of low-productivity subsistence and
informal work, and would allow the economy to substitute the import of basic products with domestic production.
An expanding exports sector is also likely to attract foreign investments which, in addition to their macro stabilizing
effects, would also bring new know-how and technologies to the country. Overall, a healthy and expanding exports
sector increases economic diversification and resilience and can become an engine of growth and job creation.

Unlike in other developing and peer countries, exports have not contributed to economic growth in Nepal.
Instead, the decline in exports widened the country’s trade deficit substantially during the 2000s, financed by in-
creasing remittances (Figure 1.9). Relative to GDP, exports have fallen to an annual average of 7 percent after 2014,
one-third of the level of structural peers and around one-fifth of aspirational peers. The COVID-19 pandemic caused
a temporary drop in exports to a record low of 5 percent of GDP in 2021, driven by the absence of tourists. In real
terms, the level of Nepal’s annual exports barely rose since 2001, compared to a fivefold increase in structural peers,
and a ninefold increase in aspirational peers (Figure 1.10).

Figure 1.9. Remittances financed Nepal’s growing                                            Figure 1.10. … which was driven by stagnating
trade deficit…	                                                                             exports.13
                 50                                                                                                        1,000
                                                                                            l Exports Ind x (2001 = 100)




                 40                                                                                                         800
P rc nt of GDP




                 30                                                                                                         600

                 20                                                                                                         400

                 10                                                                                                         200

                                                                                                                              0
                 0
                                                                2014
                      1996

                             1999



                                           2005




                                                                       2017



                                                                                     2023
                                    2002




                                                                              2020
                                                  2008




                                                                                                                                                                                                  2019
                                                         2011




                                                                                                                                                        2007


                                                                                                                                                                      2011
                                                                                                                                                               2009


                                                                                                                                                                             2013
                                                                                                                                                                                    2015
                                                                                                                                   2001
                                                                                                                                          2003
                                                                                                                                                 2005




                                                                                                                                                                                                         2021
                                                                                                                                                                                           2017




                                                                                                                                                                                                                2023
                                                                                            R




                             Exports              Imports              R mitt nc s                                                 N p l                   Structur l                        Aspir tion l
Source: WDI October 2024 and World Bank staff calculations.                                 Source: WDI October 2024 and World Bank staff calculations.	


                                                                                                                                   Nepal Country Economic Memorandum I 7
Several factors may have contributed to Nepal’s missing exports, firstly a loss of price competitiveness
through appreciating bilateral real exchange rates (RERs). The decay of Nepal’s external competitiveness was
likely the result of several factors, including the challenging geography coupled with poor infrastructure. A loss of
price competitiveness, less frequently studied in the context of Nepal, may have contributed significantly as well.
Nepal’s Rupee was pegged to the Indian Rupee in 1993, without any subsequent adjustments to the peg. Higher
inflation in Nepal compared to the main trading partners, India and the United States, has appreciated bilateral
RERs. While average inflation in Nepal decreased over the past decades, the average inflation differential compared
to India still turned positive after 2014 and led to a real appreciation (Figure 1.11).


Figure 1.11. Real exchange rates appreciated…                                           Figure 1.12. … which appears correlated with the
                                                                                        increase in remittance inflows.
                                120                                140                                    30                                   130
 Low r RER qu ls Appr ci tion




                                                                                                          25                                   120




                                                                                                                                                     Ind x (2007=100)
                                                                   120                                                                         110




                                                                                        R tio (p rc nt)
                                                                                                          20

                                                                          LCU p r US$
                                100
                                                                                                                                               100
                                                                   100                                    15
                                                                                                                                               90
                                                                                                          10
                                80                                                                                                             80
                                                                   80                                      5                                   70
                                                                                                          0                                    60
                                60                                 60




                                                                                                               2023
                                                                                                               2019
                                                                                                               2007

                                                                                                                2011
                                                                                                               2009

                                                                                                               2013
                                                                                                               2015
                                                                                                               2001
                                                                                                               2003
                                                                                                               2005




                                                                                                               2021
                                                                                                               2017
                                      2001
                                      1999

                                      2003
                                      2005




                                      2021
                                       2017


                                      2023
                                      2019
                                      2007

                                       2011
                                      2009

                                      2013
                                      2015
                                      1997




                                                                                                                REM/GDP         REER (rhs)
                                      RER US$   RER INR   NER US$ (rhs)
Source: WDI October 2024; Darvas (2021); World Bank staff                               Source: WDI October 2024; Darvas (2021); World Bank staff
calculations.                                                                           calculations.




Remittance inflows may have been a significant contributor to the appreciation of the real effective exchange
rate (REER) and the resulting decline of Nepal’s tradeable sector. The evolution of remittance inflows, the REER
(the trade-weighted average of bilateral RERs), and the tradeable and non-tradeable sectors raise concern that the
former fueled a Dutch disease-like effect, i.e., remittances boost consumption and prices in the non-tradeable sec-
tor, thereby reducing export competitiveness. Figure 1.12 suggests a positive relationship between remittances and
Nepal’s REER, while Figure 1.13 suggests a negative relationship between remittances and the ratio of tradeable to
non-tradeable sector value added. Chapter 2 will discuss the relationship between remittances and real exchange
rates in more detail.




8 I Nepal Country Economic Memorandum
Figure 1.13. The tradeable sector ratio declined while                                                             Figure 1.14. …and Nepal was relatively closed to
remittance inflows increased…                                                                                      cross-border financial flows.

          30                                                                                       1.2                0.6                      0.55
          25                                                                                       1.0                0.5
                                                                                                                                                      0.43                    0.44
          20                                                                                       0.8                0.4                                    0.37




                                                                                                         P rc nt
P rc nt




                                                                                                                                                                       0.35
          15                                                                                       0.6
                                                                                                                      0.3
          10                                                                                       0.4                                                              0.23
                                                                                                                      0.2     0.16 0.16 0.16
           5                                                                                       0.2
          0                                                                                        0.0                0.1
                                                  2011
                                           2009


                                                         2013
                                                                2015
               2001
                      2003
                             2005




                                                                                     2021
                                                                       2017



                                                                                            2023
                                                                              2019
                                    2007




                                                                                                                     0.0
                                                                                                                                  N p l         Structur l   Aspir tion l
                        REM/GDP                                                                                             Conflict        Post-Conflict    R p t d Shocks
                        Tr d bl vs. Non-Tr d                             bl R tio (rhs)                                     1996-2006      2007-2014       2015-2021

Source: WDI October 2024 and World Bank staff calculations.                                                        Source: Chinn, Menzie D. and Hiro Ito (2006)
                                                                                                                   Note: Higher index means more open capital account, zero equals
                                                                                                                   complete closure, 1 complete openness.


The appreciation of the REER not only negatively affects the price competitiveness of Nepal’s goods in foreign
markets, but also domestic production and inflation. A REER appreciation may push domestic wages, which was
observed in Nepal, if workers successfully demand higher compensation in an environment of rising domestic prices.
Particularly in the absence of rising productivity, these wage increases further deteriorate the competitiveness of
the tradeable sector by increasing production costs. Higher wages and production cost in a relatively unproductive
economy ultimately deter foreign companies to invest or set up shop in the country. Finally, rising wages can also
lead to an inflation spiral, further decreasing competitiveness.

A second factor may have been Nepal’s limited openness to capital flows, which impeded foreign investment.
Reflecting the fixed exchange rate, Nepal had to introduce capital flow restrictions to maintain monetary autonomy,
which makes the country less open to international financial flows than peers (Figure 1.14). In addition, Nepal restricts
international payment flows, which tends to penalize the development of small-scale modern services exports, such
as software design and professional business services. For a landlocked country for which modern services exports
could be a high potential activity to add value, create good quality jobs, and secure foreign exchange, this penalty
has a high opportunity cost.

Net FDI inflows were accordingly low over the past decades. Nepal has the lowest level of net FDI inflows relative
to GDP across the region and among peers. Average annual inflows increased only marginally from 0.2 percent of
GDP during the conflict period to 0.4 percent during the repeated shocks. In nominal terms, net FDI inflows increased
in the repeated shocks period to an average of US$ 125 million per year, compared to US$ 53 million on average
during the post-conflict years, however, with a significant drop in 2022 to around US$ 65 million. The stock of FDI
reached around US$ 2.2 billion in mid-2023, more than half of it consisting of paid-up capital. The electricity sector
accounted for one-third of the FDI stock, with sound increases during recent years, driven by hydropower. Manufac-
turing accounted for roughly 30 percent and the financial and insurance services sector for 25 percent. The entire
agriculture sector, on the other hand, accounted for only 0.1 percent of the FDI stock. India accounted for one-third
of the total FDI stock, with about half of their investment directed into the electricity sector.

A third factor behind missing exports stems from Nepal’s fiscal reliance on trade taxes and de-facto tariffs,
which hinder the development of a dynamic export sector. High tariffs introduce an anti-export bias in the econ-
omy and affect domestic competitiveness and exporters through various channels. Input tariffs on intermediate
goods and raw material increase costs for domestic producers and exporters. Higher costs can prevent domestic



                                                                                                                                Nepal Country Economic Memorandum I 9
exporters from upgrading the quality of their products, which may be a reason behind the low quality of Nepal’s
exports. High tariffs on imported final goods increase incentives for firms to produce for the domestic market, de-
crease competition and thereby innovation and competitiveness. In addition to tariffs, many excise taxes in Nepal
are de-facto tariffs, in that they are higher for imported goods as compared to domestically produced ones.

Trade taxes alone accounted for nearly 45 percent of tax revenue on average during 2015 – 2023, exposing
public finances to external shocks. The import restrictions imposed by the government in 2023 revealed another
downside of the heavy reliance on trade-related taxes, the fiscal exposure to volatile trade flows. The restrictions
reduced imports as intended and improved the external balance. However, they also led to an unintended fall in fiscal
revenues through lower trade-related tax income and resulted in a decade high fiscal deficit of 5.8 percent of GDP.

Most-favored nation (MFN) applied tariff rates are higher than in peers and relatively dispersed. 99.4 percent
of tariffs are bound by an upper limit, a higher share than in most peers. The simple average final bound in 2023
was 26.1 percent, significantly higher for agricultural products with 41.1 percent, and lower for non-agricultural prod-
ucts with 23.7 percent. The simple average MFN tariff applied was 12.7 percent, with a higher agriculture tariff of
15.7 percent, and a lower non-agriculture tariff of 12.3 percent. This compares to a simple average MFN tariff rate
of 9 percent in structural peers, and 4 percent in aspirational peers. Tariffs are designed with a positive escalation,
applying lower rates on primary and intermediate goods, and higher rates on final goods. Overall, eight ad-valorem
rates were applied, but dispersion has been significant, meaning that similar goods may be subject to different rates,
which makes the tariffs less predictable and transparent.

Finally, political instability and policy uncertainty emerged as key issues for exporters. Nepal has experienced
numerous changes in governments after becoming a Republic in 2008, along with corresponding delays in policy
implementation, such as opening the country to FDI inflows. Uncertainty and changes affect firms’ investment and
planning decisions and may deter them from pursuing a successful export strategy. The outcomes of World Bank
enterprise surveys over time appear to confirm this issue. In the 2023 survey, around 70 percent of direct and indi-
rect exporters highlight political stability as a major or severe obstacle to their operations.

Nepal’s export landscape, however, has shown promise through the growth of ICT and hydropower exports.
The ICT sector has been a consistent driver of export revenues, accounting on average for 10 percent of Nepal’s total
service exports or 0.3 percent of GDP over the past years. This positions Nepal as a competitive player in South
Asia, ranking second only to Pakistan in ICT service exports. Meanwhile, hydropower exports have also surged, with
surplus electricity sold to India during the rainy season. Between 2022 and 2024, electricity exports increased from
39 MW or 0.1 percent of GDP to 941 MW or 0.3 percent of GDP, marking a milestone for Nepal as it became a net
electricity exporter for the first time in 2024. These exports could contribute to a sustainable growth in Nepal’s ex-
port portfolio.




10 I Nepal Country Economic Memorandum
Box 1.1. Nepal’s exports




                           Nepal Country Economic Memorandum I 11
1.2.2.	 Production approach

Developing countries have increasingly bypassed the historically observed pattern of industrialization and
moved from agriculture to services. Economic development and growth in developing countries have been driven
historically by a process of industrialization, whereby production factors move from agriculture to manufacturing,
before moving to the services sector. More recent economic literature has documented, however, a departure from
this historical trend, with today’s developing countries experiencing shorter and less pronounced periods of indus-
trialization (Gollin 2018). This could reflect a lack of similar industrialization opportunities for today’s developing
countries as they were presented to today’s advanced economies during their development stages. As a result, de-
veloping countries move to a more service-based economic structure at much lower levels of income (Rodrik 2016).

The observed premature deindustrialization trend is evident in Nepal’s economy, where services have ac-
counted for a large part of real growth, while industry never gained momentum (Figure 1.15). Services’ contri-
bution to real GDP growth has been increasing from a high level throughout the three considered periods. Already
in the conflict period, services accounted for an average 2.1 percentage points of real growth. During the repeated
shocks period, services’ contribution increased to 2.3 percentage points on average, despite the contraction in 2020.
Agriculture contributed less to real growth over time, 1.2 percentage points on average during the conflict period,
down to 0.8 percentage points during the latest period. Industry has been the smallest contributor to real growth,
stagnating at a low level of 0.8 percentage points during the repeated shocks period.


Figure 1.15. Services were the key component of                 Figure 1.16. … and accounted for a high share of the
growth on the supply side…                                      economy.
                                                                            60
                                                                l GDP (%)




                     3.0
 l Growth




                                                                            50
                                                                            40
                     2.0                                                    30
                                                                Sh r in r




                                                                            20
 Contribution to R
             (PP)




                                                                            10
                     1.0
                                                                            0
                                                                                                      Aspir tion l




                                                                                                                                           Aspir tion l




                                                                                                                                                                                Aspir tion l
                                                                                 N p l




                                                                                                                      N p l




                                                                                                                                                           N p l
                                                                                         Structur l




                                                                                                                              Structur l




                                                                                                                                                                   Structur l
                     0.0
                             Conflict Post-Conflict    R p t d
                           1996-2006 2007-2014        Shocks
                                                    2015-2023                      A ricultur                           Industr                              S rvic s
                            A ricultur   Industr    S rvic s                      Conflict                            Post-Conflict                         R p t d Shocks
                                                                                  1996-2006                          2007-2014                            2015-2023
Source: WDI October 2024 and World Bank staff calculations.
                                                                Source: WDI October 2024 and World Bank staff calculations.



The robust dynamics of Nepal’s service sector led to a stronger shift of the economy towards services than
in peer countries (Figure 1.16). Services have been the dominant sector in Nepal over the past two decades. Its
average share in real GDP increased from 44 percent during the conflict period to 49 percent during the period of
repeated shocks, despite a significant contraction during 2020. The shift towards services was less pronounced in
peer countries. In structural peers, the average share of services in real GDP increased by 2 percentage points since
the conflict period to 50 percent in the repeated shocks period. In aspiration peers, the share of services in real GDP
fell over the same time by 1 percentage point to 43 percent.




12 I Nepal Country Economic Memorandum
The agriculture sector remains more important than in peer countries, but its share in the economy decreased
alike. The average share of agriculture in Nepal’s real GDP decreased from 33 percent during the conflict period to
27 percent during the period of repeated shocks. Despite the decrease, the sector accounts for a larger share of
real output compared to peer countries. In structural peers, the share of agriculture in real GDP fell to an average 12
percent during the repeated shocks period, in aspiration peers to 15 percent.

The lack of dynamism in Nepal’s industry sector has led to its stagnation, in contrast to some growth in peer
countries. The share of industry in real GDP remained at a low level of 14 percent over time. Industries in peer coun-
tries were more dynamic than in Nepal, even though also less than their service sectors. In structural peers, the av-
erage share of industry in real output increased from 27 percent during the conflicts period to 30 percent during the
repeated shocks period. In aspirational peers, the share increased from 25 percent to 31 percent over the same time.

Manufacturing, historically an engine of growth in developing countries, has been on a constant decline in
Nepal (Figure 1.17). The share of manufacturing in real GDP was low from the outset but decreased further over
time, from an average 7.3 percent during the conflict period to 5.7 percent during the repeated shocks period. This
manufacturing slump has been reflected in the sluggish trend of Nepal’s exports mentioned before. Construction
superseded manufacturing as the largest subsector in the post-conflict period and accounted for roughly 7 percent
of real GDP during the repeated shocks period. Both subsectors contracted during 2023, when import restrictions
led to declined imports and availability of construction and input material.

Hydropower boosted electricity production and could emerge as a bright spot and enabler of higher future
industrial growth. Nepal features among the top countries worldwide in terms of hydropower potential, albeit only
a fraction of it has come online so far. While the share of hydroelectricity production in real GDP is still small, it was
nevertheless the fastest growing subsector during the repeated shocks period, with its real output increasing by an
annual 15 percent on average. The electricity sector also recorded sound growth during the COVID-19 pandemic and
installed hydropower capacity increased from 787 megawatt (MW) in 2015 to nearly 2990 MW in 2024.

Increased hydroelectricity production could boost growth by reshaping the comparative advantage of the
economy in several ways. Hydropower could increase Nepal’s competitiveness by providing reliable, clean, and
cheap energy, reducing the reliance on imported fossil fuels and lowering production costs for industries. Aside from
attracting investment, cheap and reliable energy could also stimulate growth in manufacturing and construction.
Finally, hydropower could enhance the competitiveness of Nepal’s goods and services through green and sustainable
branding. Chapter 4 of this report will discuss hydropower in detail.

Wholesale and retail remain the largest subsector in services (Figure 1.18). Its share in real GDP nevertheless
decreased from 19 percent during the conflict period to 16 percent during the repeated shocks period. Real estate,
the second largest subsector, accounted for 8.4 percent of real GDP on average during the latest period, yet its share
in real GDP was also declining.




                                                                        Nepal Country Economic Memorandum I 13
Figure 1.17. Construction became the largest compo-                     Figure 1.18. … wholesale and retail services of the
nent of the industry sector... 	                                        services sector.

            20                                                                      60
l GDP (%)




                                                                        l GDP (%)
                                                                                    50
            15
                                                                                    40
            10                                                                      30
Sh r of R




                                                                        Sh r of R
                                                                                    20
             5
                                                                                    10
            0                                                                       0
                      Conflict   Post-Conflict        R p t d                                Conflict       Post-Conflict    R p t d
                    1996-2006    2007-2014           Shocks                              1996-2006        2007-2014       Shocks
                                                   2015-2023                                                            2015-2023
                                                                                     Whol s l & R t il            R l Est t
                 M nuf cturin   Construction       El ctricit
                                                                                     Tr nsport tion               Educ tion
                 Minin          W t r
                                                                                     Oth r S rvic s
Source: National Statistics Office and World Bank staff calculations.   Source: National Statistics Office and World Bank staff calcula-
                                                                        tions.	




Despite its potential, the tourism sector still underperforms significantly. Accommodation and food services
accounted for a mere 1.5 percent of real GDP on average during the repeated shocks period, showing limited mo-
mentum with an average annual growth rate of 4 percent. While tourist arrivals have been recovering from the
COVID-19 pandemic, the lack of connectivity and service quality continue to deter more and higher spending arriv-
als. As a result, the per capita daily tourist spending of US$ 40 remains low in comparison to peers. Nepal has also
not exploited the potential of developing a sustainable tourism brand, which could help to attract more tourists from
higher income brackets.

ICT services, however, show promise to drive export-led growth in the future. While its relative size remains
rather small, accounting for around 4 percent of real GDP during the repeated shocks period, ICT services have
increasingly contributed to growth. ICT services by now account for around 10 percent of total service exports,
positioning Nepal competitively in the region. Nepal also outperformed its regional peers in the export of digitally
delivered services, which accounted for half of total service exports by the end of 2023. Chapter 5 of this report will
discuss ICT services in more detail.


1.2.3.	 Long-term growth

The Solow-Swan growth model is a foundational framework for understanding the drivers of long-term eco-
nomic growth. In this model, the key contributors to sustained growth are labor, capital, and total factor productiv-
ity (TFP). TFP represents the efficiency with which labor and capital inputs are used to produce output and is closely
tied to technological progress, institutional quality, and other productivity enhancing factors. Often referred to as
the “growth residual,” TFP is calculated by subtracting the combined contributions of labor and capital from overall
economic growth, capturing the portion of growth that stem from improvements in efficiency, innovation, or struc-
tural changes that enhance economic output.




14 I Nepal Country Economic Memorandum
Figure 1.19. Capital accumulation drove long-term growth.

     Growth Contribution    6
                points)     5
                            4
                            3
                            2
     (p rc nt




                            1
                            0
                           -1
                           -2
                                  Conflict           Post-Conflict            R p t d Shocks          1996 - 2023
                                1996-2006           2007-2014                  2015-2023
                                                               TFP     L bor      C pit l

Source: World Bank Macro Poverty Outlook, October 2024 and World Bank staff calculations.



Capital accumulation, reflecting increased investment, was a major driver of long-term growth (Figure 1.19).
During both the conflict and post-conflict periods, capital contributed roughly 3 percentage points on average to
real GDP growth, accounting for over two-thirds of overall growth. The stability of its contribution during the conflict
years suggests that, despite political instability, certain sectors like construction and infrastructure development
received sustained investment, supported by remittances, grants, and concessional financing.

Post-2014, in the context of shocks, capital accumulation accelerated and contributed 4.4 percentage points
to real GDP growth. The sharp increase can be attributed to reconstruction efforts following the 2015 Gorkha
earthquake, which triggered significant investments in housing, infrastructure, and public facilities. Throughout all
three periods, capital therefore remained the dominant source of growth, reflecting Nepal’s dependence on physical
infrastructure development rather than labor or productivity improvements.

In contrast, labor barely contributed to real GDP growth, reflecting Nepal’s persistently low formal labor force
participation rates. Over the entire period from 1996 to 2023, labor contributed just 0.5 percentage points to growth.
This limited contribution reflects Nepal’s reliance on remittances from the large-scale migration of Nepalese workers
abroad. Surprisingly, labor’s lowest contribution came during the post-conflict period. This can be explained by the signif-
icant surge in outmigration during these years, as despite the peace, more workers sought better-paying jobs overseas.
Although labor’s contribution recovered somewhat after 2015, it remained low during the repeated shocks period, as
natural disasters and the COVID-19 pandemic disrupted employment opportunities and led to continuous outmigration.

The contribution of TFP was limited and varied significantly over time. Across all three periods, TFP contributed
only 0.25 percentage point to real growth, accounting for 6 percent of overall GDP growth. During the domestic con-
flict period, TFP’s contribution was a modest 0.49 percentage points, or 12 percent of growth. This lower contribution
likely reflected the political instability and disruptions to economic activity caused by the Maoist insurgency, which
undermined productivity improvements by deterring investment in modern technologies and efficient practices.

After the end of the conflict, TFP’s contribution rose sharply to 1.3 percentage points, or 29 percent of growth
during the post-conflict recovery. This increase can be linked to a period of increased political stability, which en-
couraged investment in new technologies, improvements in institutional frameworks, and enhanced service delivery.
The growth of sectors like ICT also played a role in boosting productivity, as Nepal began exporting ICT services,
benefiting from foreign demand.




                                                                                 Nepal Country Economic Memorandum I 15
TFP’s contribution to growth effectively vanished post-2014, highlighting Nepal’s vulnerability to shocks. TFP’s
contribution in the repeated shocks period was in fact negative, reflecting natural disasters, particularly the 2015
earthquake, which severely damaged infrastructure, disrupted production, and led to widespread economic losses.
The trade blockade imposed by India in 2015-2016 exacerbated the situation, creating severe supply chain disrup-
tions and stalling economic activity. The COVID-19 pandemic further deepened these challenges through lockdowns,
reduced workforce participation, and disruptions in trade and tourism. Together these shocks undercut any gains in
productivity, illustrating how vulnerable Nepal’s economy remains to external shocks and structural inefficiencies.


1.3.	 Labor market developments
The structural transformation of employment has been slower than in peer countries, yielding only modest
productivity gains (Figures 1.20-1.22). While peer countries have seen a more marked reallocation of workers
from agriculture to the industry and services sectors, this shift has been far less pronounced in Nepal. In addition,
the benefits of such reallocation, particularly in driving productivity improvements, have been more limited. Peer
countries have demonstrated higher productivity gains across sectors, including in the services sector, highlighting
Nepal’s missed opportunities in capitalizing on such transitions for economic growth and development.

Figure 1.20. The efficiency-enhancing reallocation of workers was slow in Nepal.	

                                                                                            25                 KHM                                        25
  in mplo m nt sh r (pp)




                                                                   in mplo m nt sh r (pp)




                                                                                                                                 in mplo m nt sh r (pp)
                           MDA 20                                                                                                                                         KHM
                                                                                            20                                                            20
                                 10                                                                                                                                 BOL         BGD
                                                                                                                                                                                 KGZ
                                                                                                                                                          15
                                 0                                                          15                       BGD
                                                                                                                                                                          NPL
                                          NPLBOL                                                     KGZ                                                  10
                                -10
                                                                                            10                                                             5
                                                   KGZ
                                -20                 BGD
                                                                                             5                                                             0
                                                                                                        BOL
                                -30                                                                  NPL
                                                                                                                                                          -5                               MDA
                                                KHM                                                   MDA
                                                                                            0
                                -40                                                                                                                       -10
  Ch n




                                                                   Ch n




                                                                                                                                 Ch n



                                                                                            -5                                                            -15
                                -50
                                                                                                 0         1    2      3     4                                  0         1     2      3    4      5
                           -2         0    2          4        6
                                  Productivit      rowth (%)                                         Productivit     rowth (%)                                      Productivit        rowth (%)

Source: World Development Indicators, October 2023.



The rate of job creation has been slower in Nepal than in peer countries and below the growth of the working
age population.15 As a result, the country’s employment ratio fell by an average 0.46 percentage points per year
between 2000 and 2022, and the decline was larger for men than for women (Figure 1.21). Nepal started from a
relatively high employment level compared to peer countries when they had similar income per capita levels, but the
downward trend over the past decades sets Nepal apart.




16 I Nepal Country Economic Memorandum
Figure 1.21. Nepal’s annual employment ratio change                   Figure 1.22. … and non-agriculture employment in
was negative from 2000 – 2022…                                        2022 was lower than in peers.

                     0.8                                                                   60
points of workin -




                                                                      points of workin -
                                                                                           50
                     0.4
popul tion




                                                                      popul tion
                                                                                           40

                     0.0                                                                   30

                                                                                           20
                     -0.4
P rc nt




                                                                      P rc nt
                                                                                           10

                     -0.8                                                                  0
                            BGD   BOL     KGZ   KHM   LAO   MDA NPL                              BGD BOL KGZ KHM LAO MDA NPL
                                  Tot l     F m l       M l                                       Industr     S rvic s    A ricultur

Source: International Labor Organization; Penn World Tables; Rup-     Source: International Labor Organization; Penn World Tables; Rup-
pert Bulmer et.al; World Development Indicators, October 2023.        pert Bulmer et.al; World Development Indicators, October 2023.



The decrease in the overall employment ratio stemmed from a reduction in agricultural employment, with
non-agricultural sectors unable to generate enough jobs to compensate for this decline. The shift of labor from
agriculture to non-agriculture follows a typical path of structural transformation, although countries may differ
in the speed of the transformation. Nepal started the transformation relatively late. In 2000, the country had the
highest agriculture employment ratio among South Asian countries and the second highest among peers, after Lao.
Its services employment ratio was the lowest in South Asia and only slightly above that of Lao. During 2000-2022,
agriculture employment ratio fell by one percentage point per year, on par with most peers. However, employment
ratios in industry and services sectors grew only by around 0.25 percentage points per year, below most peer
countries.16

The service sector employment ratio increased over time, yet slower than in peer countries. Nepal’s services
employment ratio was propelled by a rapidly growing real estate market, growing links between tourism and busi-
ness services, and expanding digital services exports (World Bank 2021, 2023). But in comparison to peers, its ser-
vices employment ratio increased slower during 2000-2022. As a result, the country’s non-agriculture employment
ratio in 2022 was lower than all comparator countries except for Lao (Figure 1.22).




                                                                                                Nepal Country Economic Memorandum I 17
   Box 1.2. Labor Productivity




    Figure 1.23. Labor Productivity in 2022                           Figure 1.24. Labor Productivity by Sector in
                                                                      2022
                                7
    d




                                                                                                  30                                  5




                                                                                                                                          d
                                                                      d
                                6
    Thous nds of US$ p r mplo




                                                                                                                                          Thous nds of US$ p r mplo
                                                                      Thous nds of US$ p r mplo
                                                                                                  25                                  4
                                5
                                                                                                  20
                                4                                                                                                     3
                                                                                                  15
                                3                                                                                                     2
                                                                                                  10
                                2
                                                                                                   5                                  1
                                1
                                                                                                  0                                   0
                                0                                                                      MDA BOL LAO BGD KGZ KHM NPL
                                    MDA BOL   LAO   BGD KGZ KHM NPL
                                                                                                       Industr    S rvic s   A ricultur




18 I Nepal Country Economic Memorandum
     Figure 1.25. Agriculture - Deviation from EMDE         Figure 1.26. Non-Agriculture - Deviation from
     long-run employment ratio                              EMDE long-run employment ratio

                                                                         60
                  60




                                                            popul tion
     popul tion




                                                            points of
                                                                         40
     points of



                  40
                                                                         20
                  20

                   0                                                      0




                                                            workin -
                                                             P rc nt
      P rc nt
     workin -




                  -20                                                    -20

                  -40                                                    -40
                        BGD BOL KGZ KHM LAO MDA NPL                             BGD BOL KGZ KHM LAO MDA NPL




Women have predominantly engaged in less productive and mostly informal agricultural work and slow job creation
has held them back more than men. Nepal’s employment ratio for women, at around 70 percent including subsist-
ence work, is higher than most other South Asian countries and higher than in half of the peer countries. Most of
these jobs, however, are informal. The share of women working in non-agriculture is low, and women’s employment
ratio in non-agriculture is even lower than the average non-agriculture employment in the economy. Compared to
the EMDE average, Nepal’s long-run women’s non-agriculture employment ratio is 20 percentage points lower.

Greater openness to trade, more flexible trade regulations, easier access to finance for firms, and better
educational outcomes could boost long-run employment. Several policies have been significantly correlated with
higher long-run non-agriculture employment ratios in the sample of EMDEs. Among these, Nepal’s export-to-GDP
ratio and literary rates are in the bottom quartile of other EMDEs, and more firms in Nepal than the EMDE average
cited customs and trade regulations and access to finance as major constraints. Trade liberalization has been as-
sociated with more job-rich growth in regions and industries with less restrictive labor regulations in India (Hasan,
Mitra, and Ramaswamy 2007). Greater access to finance can stimulate investment, which in turn can lead to pro-
ductivity growth, firm expansion, and employment growth. A better-educated work force is needed to facilitate the
shift of labor into non-agriculture. Based on the empirical estimates, if Nepal could improve openness to trade and
educational outcomes and have more flexible trade regulations and easier access to finance for firms, its long-run
non-agriculture employment ratio could have been higher by 1.5 to 13.5 percentage points, and total employment
ratio could have been up 3 percentage points.


1.4.	 Looking ahead: Drivers of future growth
Nepal defined ambitious growth targets in their National Development Plan (NDP) and Medium-Term Ex-
penditure Framework (MTEF). Nepal’s governments outline their development priorities, policies, and programs
in periodic medium-term NDPs. The 16th NDP, presented in May 2024, targets an average annual real GDP growth
rate of 7.1 percent over 2025-2029, significantly above the rates observed during the three periods considered in this
chapter. The most recent 2024 MTEF aims at average annual real growth of 6.7 percent during 2025–2027.

Baseline projections, however, do not corroborate authorities’ ambitions. The projections summarized in Fig-
ures 1.27– 1.30 were derived using an enhanced World Bank Macro-Fiscal Model (MFMOD). The baseline scenario
assumes no major shift in policies and estimates potential growth to increase to around 4.5 percent until 2030,
before eventually slowing to 3.8 percent in 2040 and 3.3 percent in 2050 (Figure 1.27). Real GDP is expected to



                                                                               Nepal Country Economic Memorandum I 19
rebound to above potential growth in the shorter-term, but nevertheless remain significantly below the growth rates
targeted in the recent NDP. The longer-term slowdown in potential output is driven by slower capital accumulation
after 2030. The rates are assumed to converge to those observed during the conflict period, which are in line with
the mean observed in LMICs during the two decades before the pandemic (Figure 1.28). TFP growth is derived in a
similar way and expected to increase gradually until 2030 to growth rates in line with the mean growth observed in
LMICs before the pandemic. Finally, the limited contribution of labor to long-term growth reflects slower population
growth and labor market participation rates.

Figure 1.27. Baseline growth projections are signifi-                                                                        Figure 1.28. … reflecting lower capital accumulation
cantly below authorities’…                                                                                                   over the medium- to long-term. 	
                   10                                                                                                                                     5
l GDP Growth (%)




                                                                                                                                 Contribution to Growth
                   8                                                                                                                                      4




                                                                                                                                               points)
                   6
                                                                                                                                                          3
                   4




                                                                                                                                  (p rc nt
                                                                                                                                                          2
                   2
R




                   0                                                                                                                                      1
                                                                                                              2048
                                        2028




                                                                                                       2046
                                2026


                                               2030




                                                                                                                     2050
                                                             2034
                                                      2032




                                                                                  2040
                                                                           2038



                                                                                                2044
                         2024




                                                                                         2042
                                                                    2036




                                                                                                                                                          0
                                                                                                                                                                2024-50              2025-29               2030-39               2040-49
                                Pot nti l R l Growth                                     NDP R          l Growth
                                R l GDP Growth                                                                                                                Inv stm nt                   TFP           Structur l Emplo m nt

Source: World Bank staff calculations.                                                                                       Source: World Bank staff calculations.


Unsurprisingly, boosting low TFP closer to the rates observed in other LMICs would bring the largest gains
over the baseline. An ambitious reform agenda could increase the country’s productivity growth beyond the base-
line assumptions and closer to the rates observed in other LMICs, for example by implementing trade enhancing
policies or attracting more FDI. If TFP were to grow at a rate equivalent to the 75th percentile observed in LMICs
during 2000 – 2019, then the real output level would be roughly 20 percent higher by 2050 (Figure 1.29). The gains
from higher investment rates are considerable but less pronounced over the long-term. If public and private invest-
ment relative to GDP were to reach the 75th percentile of what was observed in other LMICs, real output would still
increase by around 10 percent compared to the baseline. Finally, a conservatively estimated constant labor force
participation rate increase of 2 percent would result in an equivalent increase of the real GDP level by 2050.

Figure 1.29. Higher productivity and factor accumu-                                                                          Figure 1.30. … while permanent outmigration and
lation would boost growth…                                                                                                   lower remittances would slow it.
                         25                                                                                                                               2
B s lin R l GDP L v l
P rc nt D vi tion from




                                                                                                                             B s lin R l GDP L v l
                                                                                                                             P rc nt D vi tion from




                                                                                                                                                          0
                         20
                                                                                                                                                          -2
                         15
                                                                                                                                                          -4
                         10                                                                                                                               -6

                          5                                                                                                                               -8
                                                                                                                                                      -10
                         0
                                                                                                                                                      -12
                                       2027


                                                      2031




                                                                                                                      2049
                                               2029


                                                             2033
                                                                    2035




                                                                                                2043
                                                                                                       2045
                              2025




                                                                           2037
                                                                                  2039
                                                                                         2041



                                                                                                              2047




                                                                                                                                                                                                                2039
                                                                                                                                                                      2027


                                                                                                                                                                                    2031




                                                                                                                                                                                                                                                   2049
                                                                                                                                                                             2029


                                                                                                                                                                                           2033
                                                                                                                                                                                                  2035




                                                                                                                                                                                                                                            2047
                                                                                                                                                                                                                              2043
                                                                                                                                                                                                                                     2045
                                                                                                                                                               2025




                                                                                                                                                                                                         2037


                                                                                                                                                                                                                       2041




                                     TFP 75th                                        L bor 90th
                                     Inv stm nt 75th                                 Exports Mod r t                                                             R m Down                           Mi r Hi h                         Mi r Low

Source: World Bank staff calculations.                                                                                       Source: World Bank staff calculations.



20 I Nepal Country Economic Memorandum
Nepal could also boost economic development by taking better advantage of growth opportunities from exports
and hydropower. Increasing exports at a moderate pace, closing the export gap identified in World Bank (2021)
over the course of a decade, would increase the real GDP level already by 2 percent over the medium-term, and 3
percent over the long-term.17 More aggressive policies to promote exports would have even stronger output effects.
The CCDR (WB 2022) estimated the effects of additional hydropower investments of US$ 6.4 billion until 2033 on
real output. Additional capacity would lead to higher exports and fiscal revenue and boost annual real GDP by 0.5
percent by 2033. The output effect of additional hydropower capacity could be even higher, as the modeling did
not include the effects of higher electricity supply on domestic production.

Nepal’s current growth model, however, could also deliver slower economic development should remittance or
migration dynamics shift (Figure 1.30). Remittances going forward could decrease if economic activity in destina-
tion countries would slow or change, e.g., a slowdown of construction sectors in GCC countries. An average annual
remittance growth of 7.1 percent, roughly 2 percentage points below the baseline assumption, would suppress real
GDP levels by around 2 percent annually over the medium-term. Similarly, a change in migration patterns leading
to more people permanently relocating and reuniting with their families abroad would have a negative effect on
economic growth. If only 5 percent of migrants and their families were to remain abroad, real GDP levels would per-
manently decrease by nearly 3 percent. Assuming the share of non-returning migrant families would increase to 20
percent would lead to even more pronounced real output losses of more than 10 percent.

Climate change and natural disasters will also negatively affect long-term economic development. Events
including flooding and landslides, the related destruction of infrastructure, and lower agricultural yields will affect
long-term GDP growth. Rising temperatures likely lead to higher energy imports, higher health costs due to water
and electricity shortages, and will negatively affect already low labor productivity (WB 2022).

Going forward, Nepal should implement reforms to increase the returns from migration and generate growth
domestically. Improving export capacity through trade-enhancing reforms is crucial for long-term growth. This
could be achieved, for example, by improving price competitiveness by better managing inflationary pressures or
by revising the current tariff and excise tax structure. ICT services exports appear to hold promise for increasing
export-led growth. Investments in technology transfer and skill development could boost productivity and stimulate
the stagnating manufacturing sector. Similarly, increased hydroelectricity production could, among other positive
effects, stimulate manufacturing by providing a clean, cheap, and reliable source of energy. From a fiscal perspec-
tive, Nepal appears comparably well positioned to undertake reform, having emerged from the COVID-19 pandemic
with more fiscal space than other developing countries.18 Finally, migration will remain a key factor shaping the
country’s long-term growth, and policies improving migration outcomes are therefore critical.

The subsequent chapters of this report explore key opportunities for fostering domestic growth and present
targeted policy recommendations. Chapter 2 discusses how migration outcomes can be improved at different
stages of the migration process. Chapter 3 examines the impact of RERs and trade policies on Nepal’s exports, of-
fering strategies to stimulate export growth based on the findings. Chapters 4 and 5 focus on hydropower and the
ICT sector, two critical drivers of Nepal’s long-term economic growth, and provide actionable recommendations to
unlock the potential of these sectors.




                                                                       Nepal Country Economic Memorandum I 21
CHAPTER 2.
International Migration for
Employment and Welfare
Temporary international migration remains integral to Nepal’s economy and livelihoods. In 2021, roughly one
in four Nepali households had at least one family member abroad, amounting to 7.5 percent of the popula-
tion. The significance of migration is further underscored by officially recorded personal remittances, which
in 2023 accounted for over 25 percent of GDP, placing the country among the top five remittance-receiving
countries globally.

The migration of primarily low-skilled workers to the Gulf Cooperation Council (GCC) countries and Malaysia
has become an essential job strategy to offset the limited quality jobs at home, especially for younger workers,
who face disproportionately high unemployment rates. Consequently, young workers account for the majority
of Nepal’s migrant workforce. However, the structural lack of domestic economic opportunities presents chal-
lenges for returning migrants who seek to reintegrate and effectively utilize the capital and skills they have
gained abroad.

Remittance from Nepali workers abroad remain crucial for improving the living standards and resilience of the
origin communities, directly contributing to over 30 percent of Nepal’s poverty reduction between 2011 and
2023. The benefits of these remittances are widely felt, with households across all income levels experiencing
improved living standards, increased consumption, and enhanced investments in education, health, and food
security. Furthermore, high migration rates have positive spillover effects on local labor markets. Municipali-
ties with high migration rates show increased labor force participation and employment, particularly among
women in the service sector.

Yet, access to migration opportunities remains unequal, and the economic gains come with significant costs
for migrants and their families. Financial constraints limit migration opportunities for many households, influ-
encing both the decision to migrate and choice of destination. Migration trends are shaped by economic status,
social caste and ethnicity, and geographic location. While remittances support families, the absence of a family
member abroad often reduces labor force participation among those left behind, especially women. Migrants
themselves face high costs to migrate and often endure poor working and living conditions abroad, with limited
access to healthcare or social protection, sometimes resulting in fatalities.

A systematic, inclusive, and institutionalized approach to migration management is crucial for enhancing the
benefits of migration while reducing its costs. Policies should prioritize increasing migration opportunities
across all the population domains, the safety and well-being of migrant workers, and support skill develop-
ment to expand access to higher-quality employment abroad. Effective reintegration programs for returning
migrants would not only support them in utilizing their acquired skills but also strengthen local labor markets
and provide more opportunities for those who remain in Nepal. Expanding domestic employment options is es-
sential, as it would ease the challenges of reintegration for returnees, offer more viable choices to prospective
migrants, and ultimately build a stronger, more resilient economy.




22 I Nepal Country Economic Memorandum
2.1.	 International migration remains important, with increasing
economic returns
This chapter analyzes migration in Nepal across its various stages. It studies the migration cycle following the
framework proposed by Ahmed & Bossavie (2022) and Cho & Majoka (2020), differentiating between the pre-depar-
ture, during, and post-migration phases. Through synthesizing existing literature and integrating fresh evidence, this
chapter examines evolving migration trends and their implications for migrants and their communities of origin. A
better understanding of these underlying processes that determine the level of migration and remittances is critical
to identifying strategic interventions across the migration life cycle. The analysis leverages a new household welfare
survey and housing and population census data.


2.1.1.	Remittances contributed significantly to reducing poverty

International migration for temporary employment remains a cornerstone of Nepal’s economy and society.
After a rapid rise in the previous decade, emigration has stabilized at a higher rate over the last decade. As of 2021,
based on the latest Nepal Housing and Population Census, 23.3 percent of households had at least one member
living abroad, and absentees accounted for 7.5 percent of the country’s population. Remarkably, these overall figures
have remained relatively stable since the 2011 Census (Figure 2.1). Although there has been a marginal increase in
migration for educational purposes during this period, the primary reason for migration remains temporary employ-
ment. The propensity to migrate remains disproportionally high for the working-age population, especially work-
ing-aged men (Figure 2.1). 

Remittance inflows rank among the highest globally and contribute significantly to enhancing the country’s
living standards. In 2023, officially recorded personal remittances accounted for over one-fourth of GDP, nearly
three times as much as the second highest remittance-receiving country in South Asia, Pakistan, with 7.8 percent
of its GDP (Figure 2.2). This places Nepal in the top five remittance-receiving countries globally. Remittances signifi-
cantly surpass FDI and official development assistance and remain a vital source of foreign exchange.

Remittances directly accounted for over 30 percent of the poverty reduction between 2011 and 2023 (World
Bank, Forthcoming). They benefit households across the wealth distribution, with an increasing number of house-
holds reaping their rewards (Figure 2.3). The proportion of households receiving remittances and per capita remit-
tances from an absentee member abroad have increased substantially over the past decade, including for house-
holds at the lower end of the wealth distribution.

Figure 2.1. International migration from Nepal is high and mostly for economic work.	

    25.4                                                                                     100
           23.3
                                                                                                      82.2
                                                                         son for mi r tion




                                           19.6                                                                      77.9
                                                  16.9                                       80
                                                                        (% of bs nt s)




                                10.4 9.6                                                     60
                    7.3 7.5
                                                          2.2 3.0                            40

                                                                                             20       11.9           12.6
    Sh r of        Abs nt s      Tot l       M l          F m l
                                                                        R




                                                                                                    5.9                 9.6
   hous hold        s sh r of                                                                 0
      with         popul tion                                                                         2011          2021
    bs nt /s
                                                                                             Work r l t d         Stud
              All (%)           Sh r of workin       popul tion (%)
                                                                                             D p nd nt or oth r
                        2011    2021




                                                                       Nepal Country Economic Memorandum I 23
Figure 2.2. Personal remittances as a share of GDP                      Figure 2.3. … and per capita receipts have increased
remain high…	                                                           across the wealth distribution.
                                                                                                      80
             30




                                                                         R mitt nc s in 2023 pric s
                                                                                                      70
             25
                                                                                                      60
P rc nt of GDP




             20
                                                                                                      50
                 15
                                                                                                      40
                 10                                                                                   30
                 5                                                                                    20
                 0                                                                                    10
                      2000




                      2018
                      2004
                      2002




                      2016

                      2020
                      2022
                      2008
                      1990




                      2006
                      1994
                      1992




                      2010
                      1998




                      2014
                      2012
                      1996




                                                                                                      0
                                                                                                              1 2    3   4    5   6       7   8   9     10
                      Af h nist n                 B n l d sh                                               Poor st                                    Rich st
                                                                                                                          W   lth D cil
                      Bhut n                      Indi
                      M ldiv s                    N p l                                                      P r c pit r mitt nc s (NPR, 1000) 2011
                      P kist n                    South Asi                                                  P r c pit r mitt nc s (NPR, 1000) 2023
                      World
Source: Figure 2.1, Nepal Housing and Population Censuses 2011 and 2021; Figure 2.2 World Development Indicators World Development Indica-
tors (BX.TRF.PWKR.DT.GD.ZS; accessed on September 15, 2024); Figure 3 NLSS 2010/11 and 2022/23.
Note: Wealth deciles in Figure 2.3 are defined based on the first principal component of the household’s ownership of various durable assets,
housing characteristics, and land ownership.



Seeking employment abroad has been an important job strategy to cope with structural domestic labor mar-
ket issues, particularly for younger workers. Between 2008 and 2018, Nepal’s economy created 4 million new
jobs at an annual growth rate of 3 percent, mainly in construction, manufacturing, and services. A significant share
of the workforce, however, continues to engage in subsistence agriculture. Despite some livelihood and productivity
improvements compared to traditional farming, these new jobs are mostly informal or temporary. Furthermore,
the growth rate of jobs did not keep up with the increasing number of job seekers, particularly younger and female
workers, who consequently experience disproportionately high unemployment rates. Nearly one-quarter of those
aged 15 to 24 did not have a job in 2023, almost double the overall unemployment rate of 12.5 percent. Accord-
ingly, the share of youth not in employment, education, or training (NEET) is high at 35.7 percent, particularly for
young women. These patterns have increased slightly since 2018, underscoring the structural challenge of creating
sufficient high-quality jobs in Nepal. On the other hand, an average Nepali worker can earn three times more while
going abroad (Sapkota, Shrestha, & Shrestha, 2021). With continued high demand for Nepali labor abroad, the pull
of higher wages remains an important job strategy for Nepali workers to better their livelihoods.

Young male adults, who experience higher domestic unemployment than older workers, account for most in-
ternational migrants; for many, it is their first job when entering the labor market. Over 80 percent of migrants
are male, but the share of female migrants increased from 12.3 percent in 2011 to 17.8 percent in 2021 (NSO, 2021).
The age profile of international migrants has remained unchanged since 2011 (Figure 2.4). 44.5 percent of the 2.2
million individuals living abroad in 2021 were between ages 15 and 24, while another 31.3 percent were between 25
and 34 when leaving the country. Nepali workers seek foreign employment early in their careers, with 17.0 and 14.9
percent of 15-24 and 25-34-year-olds having already left Nepal previously for work (Figure 2.4). This is more common
among younger men than women, with 28.7 and 27.5 percent of men between 15- 24 and 25-34 years living abroad in
2021. The patterns among women are similar, but the shares are significantly lower across the age distribution. With
migration starting early in the labor cycle, many Nepali workers spent most of their economically productive years
employed abroad, through multiple migration spells, and often across different destinations (World Bank, 2020).




24 I Nepal Country Economic Memorandum
While the education level of international migrants has increased over time, the overall education level re-
mains low (Figure 2.5). More than 60 percent of absentees living abroad in 2021 had obtained only secondary edu-
cation (grades 9 to 10) or less before leaving the country, and a quarter had gained Intermediate and SLC/SEE levels
and beyond. Low educational attainments of international migrants, 8.6 years on average, reflect Nepal’s generally
low level of education. Despite improvements over the last three decades (Ruppert Bulmer, Shrestha, & Marshalian,
2020), the average years of education among the working-age non-migrant population (15 plus) is only 6.3 years,
below the average level of international migrants. Domestic migrants, on the other hand, have the highest education
level, 10.2 years on average (authors’ calculation using NLSS IV). There nevertheless is an increasing association
between higher levels of education and international migration, as reflected by the 3 percentage points increase in
the share of international migrants with some tertiary education levels over the last decade from 4 percent in 2011
to 7 percent in 2021 (Figure 2.5).

Figure 2.4. Economic migration is a young and male phenomenon…

                               45                                                                        35
    Distribution of mi r nts




                               40                                                                        30




                                                                                    Sh r of popul tion
                               35
                                                                                                         25




                                                                                        bro d, 2021
                               30
                               25                                                                        20
                               20                                                                        15
                               15                                                                        10
                               10
                                5                                                                         5
                                0                                                                         0
                                      0 to 15 to 25 to 35 to 45 to 55 to 65                                    0 to 15 to 25 to 35 to 45 to 55 to 65
                                       14   24     34     44    54    64 plus                                   14   24    34    44    54    64 plus
                                                      A cohort                                                              Birth cohort
                                            Distribution of mi r nts 2011
                                            Distribution of mi r nts 2021                                            All     M l           F m l


Figure 2.5. … and concentrated among those with                                          Figure 2.6. However, there is a gradual shift towards
intermediate/high school education or less.                                              more skilled occupations, and average earnings
                                                                                         overseas are also increasing.
                               Distribution b   duc tion t th tim of d p rtur                            70                                        65
                                                                                                                                                   60




                                                                                                                                                        S l r in 2017 NPR (1000)
                                                                                                     60
                                                                                                                                                   55
                                                    No-l v l                                         50
                                                  25%                                                                                              50
                                                                                          Sh r (%)




                           Post r du t                                                               40                                            45
                                                  20%                 Prim r                                                                       40
                                                  15%                                                30                                            35
                                                  10%                                                20                                            30
                                                   5%                                                                                              25
                                                                           Low r-                        10
              Gr du t                              0%                                                                                              20
                                                                         s cond r                        0                                         15
                                                                                                                     3
                                                                                                             20 9

                                                                                                             20 0



                                                                                                                     2
                                                                                                             20 7




                                                                                                             20 1
                                                                                                             20 8




                                                                                                                   /2
                                                                                                                   /1




                                                                                                          FY 1/2

                                                                                                                  /2
                                                                                                          FY 8/1

                                                                                                                  /2
                                                                                                                  /1
                                                                                                                16




                                                                                                               20
                                                                                                                17




                                                                                                               22
                                                                                                               19




                                                                                                               2
                                                                                                               1
                                                                                                  20




                                                                                                            20




                  Int rm di t                                         S cond r
                                                                                                FY

                                                                                                           FY

                                                                                                          FY




                                                                                                          FY
                                                                                                          FY




                                                                                                                    % r n w l p rmits
                                                    SLC/SEE                                                         % unskill d occup tion
                                                  2011         2021                                                 Monthl s l r (in 2017 NPR)
	
Source: Figures 2.4 and 2.5 - Nepal Housing and Population Censuses 2011 and 2021; Figure 2.6 – Foreign Employment Information Manage-
ment System (FEIMS).




                                                                                                              Nepal Country Economic Memorandum I 25
Despite a concentration of migration for elementary occupations in GCC countries and Malaysia, new destina-
tions have emerged, and average skills and wages have increased. Data from the Foreign Employment Information
Management System (FEIMS) show a gradual decrease in the number of people migrating for unskilled occupations
and an increase in migrant wages (see Figure 2.6).19 Between 2017 and 2022, the average monthly migrant salary
increased by over 100 percent from NPR 28,701 to 58,856. Considering Nepali workers spent multiple stints abroad,
declining renewal rates in recent years (renewals are registered only when the extension is for the same employer) could
indicate migrants’ ability to navigate to better opportunities with different employers. While there is a positive income
trajectory during employment abroad (Sapkota, Shrestha, & Shrestha, 2021), the observed salary increase may not
entirely be due to higher returns from re-migration. New migrants may have higher skill sets and migrate to newer,
more remunerative destinations. Indeed, countries in Central and Eastern Europe, the UK, Malta, and Türkiye have be-
come more prominent new emerging destinations in recent years, especially among women migrants (MOLESS, 2022).

While Nepal is not likely to experience a brain drain currently, a longer-term management strategy is needed
to utilize returns from its high-skilled emigrants. Most current migration from Nepal is temporary and is for
employment. Work permits are issued typically for an average of 2.1 years and are tied to specific jobs at the des-
tination. Given the predominantly low educational attainment and focus on low-skilled employment, Nepal’s brain
drain risk is currently low. However, there has been a slight increase in the percentage of individuals migrating for
education and training abroad, rising from 5.9 percent in 2011 to 9.6 percent in 2021. The level of education posi-
tively correlates with international migration. Additionally, individuals moving to highly developed destinations like
Western Europe, Australia, and North America have risen in recent years (Figure 2.7). This pool of migrants is more
likely to move for a longer term and/ or relocate permanently. Leveraging the network of these migrants abroad
will be crucial for the development of Nepal in the long run. They can play an important role in increased knowledge
transfer, remittances, and investment in Nepal, with significant job creation and growth potential.


2.2.	Pre-departure: The factors shaping the migration and
destination choice
Migration from Nepal can be categorized broadly into three groups of destination countries that differ in cost
and return to migration (Williams, et al., 2020; Shrestha M., 2022). The first group consists of India, a neighboring
country with an open border and a historically popular destination with a low cost of migration but low returns. The
second migration stream is to GCC and Malaysia, which have medium migration costs and medium returns and are
currently the most favored destinations. Finally, the third group is migrating to wealthy Western, Asian, and Pacific
(WWAP) countries such as Japan, the Republic of Korea, Australia, North America, and Europe. These are relatively
new destinations and their shares in overall migration remain low, with only the richest few able to afford the high
costs and reap the high benefits. While students account for a significant share of migration to WWAP countries,
there is a growing trend of nurses migrating to these destinations (Adhikari, Rai, Baral, & Subedi, 2023).


2.2.1.	 Migrants face high costs before departure

Nepali migrants, in general, face comparably high migration costs. When controlling for GDP per capita, Nepal
has the second-highest migration costs to the GCC countries after Pakistan (Figure 2.9) among the countries sam-
pled in the KNOMAD-ILO survey. For example, the average cost of migrating to Qatar in 2016 was 1.14 times Nepal’s
annual GDP per capita. The migration costs to Saudi Arabia and Malaysia were as high as 80 percent of the GDP
per capita. Migration costs in South Asia are generally high and among the highest globally, often equaling several
months of migrants’ salary (Ahmed & Bossavie, 2022). This is particularly taxing for Nepali workers. Despite the
“free-visa, free-ticket” policy implemented in 2015 for the GCC countries and Malaysia, which allows recruitment
agencies to charge a maximum of only 10,000 NPR as service fees, most recruitment agencies continue to charge
more than ten times that amount. Additionally, 85 percent of migrant workers rely on informal loans to finance their
moves, facing an average interest rate of 27 percent (Kharel, Bhattarai, & Tumsa, 2023a).



26 I Nepal Country Economic Memorandum
2.2.2.	 Socioeconomic factors affect the destination choice

Migration to more lucrative but more expensive destinations is increasing among wealthier provinces, while
low-cost and low-return destinations continue to dominate in poorer provinces (Figure 2.7). Between 2011
and 2021, the share of migrants to India and the GCC & Malaysia decreased by 3.8 and 5.5 percentage points,
respectively, while the shares to more lucrative WWAP destinations increased by 9.3 percentage points. This trend
is driven by migrants from the well-off provinces of Bagmati and Gandaki. Both provinces experienced an increase
in migration to WWAP countries by over 19 percentage points, while migration to the GCC and Malaysia, and India
decreased significantly. Koshi, another province with a poverty headcount below the national rate, also experienced
a significant increase in the share of migration to WWAP countries by almost ten percentage points during the
same period. As a result, WWAP countries have become almost as popular as GCC and Malaysia in the Bagmati
and Gandaki provinces. In Koshi and Madhesh, GCC and Malaysia are the most important destinations, while India
remains the dominant destination in the other two provinces, which are also the poorest.

Figure 2.7. Access to higher remunerative migration destinations improved over the last decade but remained
unequal across provinces…	
                                               Ch n          in th sh r of mi r nts b                                                     100                3                                         4          3
                                                                                                                                                   18                                       12                    7            19
                                              d stin tions b tw n 2011 nd 2021                                                             90


                                                                                                               Sh r of mi r nts in 2021
                                                                                                                                                                                 32                   25
                                                                                                                                           80
                                                                                                                                                                       50
                                                                       Koshi                                                               70
                                                                                                                                                                                            43
                                                              20.0%                                                                        60
                                                                                                                                                            81                                                                 47
                                                     Tot l     10.0%                       M dh sh                                         50     69
                                                                                                                                                                                 49                             91
                                                               0.0%                                                                        40
                                                                                                                                                                                                      71
                                                              -10.0%                                                                       30                          42
                                                                                                                                           20                                               45
 Sudurp schim                                                 -20.0%                             B    m tii                                                                                                                    34
                                                                                                                                           10               16                   19
                                                                                                                                                   14                   8
                                                                                                                                            0                          m tii




                                                                                                                                                                                                      K rn li
                                                                                                                                                                                 G nd ki
                                                                                                                                                            M dh sh




                                                                                                                                                                                                                Sudurp schim

                                                                                                                                                                                                                               N p l
                                                                                                                                                   Koshi




                                                                                                                                                                                            Lumbini
                                                K rn li                                    G nd ki
                                                                                                                                                                       B




                                                                     Lumbini

                                              Indi                 Gulf & M l    si                  WWAP                                          Indi               Gulf & M l           si         WWAP

Source: Nepal Housing and Population Censuses 2011 and 2021.		


Figure 2.8. … and across wealth decile.	                                                                                       Figure 2.9. While Nepali migrants face one of the
                                                                                                                               highest migration costs relative to per capita GDP.	
                                         10
with int. mi r nt b tw n 2011-23 (pp)




                                          8                                                                                                     Indi - S udi Ar bi
   Ch n in fr ction of hous holds




                                          6                                                                                                                Indi - Q t r
                                          4
                                          2                                                                                                        N p l-M l                si
                                          0
                                         -2                                                                                                     N p l - S udi Ar bi
                                         -4                                                                                                                N p l-Q t r
                                         -6
                                         -8                                                                                                           P kist n - UAE
                                        -10                                                                                               P kist n - S udi Ar bi
                                        -12
                                                1 2            3     4    5     6      7     8        9 10                                       Philippin s - Q t r
                                              Poor st                                                Rich st                         Philippin s - S udi Ar bi
                                                                     W   lth d cil
                                                                                                                                                                      0            2                                                   4
                                                       Indi         Gulf & M l        si      WWAP
                                                                                                                                                     Mi r tion costs to GDP p r c pit r tio
Source: Figure 2.8 - NLSS 2010/11 and 2022/23; Figure 2.9 – KNOMAD-ILO Migration Costs Survey 2015 and 2016 and per capita GDP from WDI.


                                                                                                                                                    Nepal Country Economic Memorandum I 27
Similarly, wealthier households are increasingly more likely to send members to destinations with high eco-
nomic returns than poorer households (Figure 2.8). The probability of households sending a member to India
decreased across the wealth groups between 2011 and 2023, especially among those in the middle of the wealth
distribution. With an already low probability of migrating to India, the decrease was smaller among the wealthiest
households. The likelihood of migrating to the GCC & Malaysia increased for the less wealthy (bottom 30 percent),
with some exceptions. Similarly, the increase in the probability of migrating to the premier WWAP destinations was
significantly more pronounced among the wealthiest households.

The link between household wealth and the destination type suggests that liquidity constraints restrict mi-
gration choices (Figure 2.10). The predictive probabilities from a multivariate logistics model show a clear pattern
of the economic class of migrants and their destination choices. Consistent with other studies in Nepal (Shrestha
M. , 2017b; Adhikari, Rai, Baral, & Subedi, 2023), migration to India is most popular among the poorest households.
Controlling for various household characteristics and geographic factors, the propensity of sending a member to
India decreases with the wealth level. The propensity of having a migrant in the GCC countries and Malaysia is rela-
tively high across the distribution but is highest among middle and upper-middle-class households (deciles 5 to 8).
However, only households in the highest wealthiest decile have a meaningful and statistically significant probability
of migrating to WWAP destination, most likely due to sufficient liquidity to cover the higher migration costs.

Figure 2.10. There is a strong wealth and migration association by destination
                                          Indi                           Gulf & M l        si                         WWAP
                    1 Poor st
                           2
                           3
       lth D cil




                           4
                           5
                           6
       W




                           7
                           8
                           9
                   10 Rich st
                                0    .1          .2        .3 0            .1         .2         .3 0            .1          .2        .3
Source: World Bank Staff estimates using the NLSS 2022/23 data.
Note: Predictive margins and their 95% confidence levels after fitting logistic models are reported in the figure. Other controls used in the mod-
els are household head’s caste/ethnicity, highest adult education in the household, household size, number of adult male members, number of
domestic migrants, log of road distance of municipality from Kathmandu, Urban/Rural status of municipality, municipality destination-specific
international migration rates, and province fixed effects. Standard errors are clustered at the primary sampling unit (PSU) level.



Wealthier migrants send more remittances, reflecting their access to higher-return destinations compared
to poorer migrants (Figure 2.11). Migrants across all wealth deciles are equally likely to send remittances home at
least once over the previous 12 months. However, there is a strong positive correlation between household wealth
and the number of times migrants sent remittances. Migrants from wealthier households also sent significantly
more remittances, with those in the wealthiest decile sending 5.1 times more remittances than those in the poorest
decile. Destination-specific results show that the premier destinations with high migration costs are associated
with significantly higher returns compared to the lower-cost destinations. While most migrants finance their moves
to the GCC and Malaysia with high-interest loans (Kharel, Bhattarai, & Tumsa, 2023a), this may not be feasible to
finance even costlier WWAP destinations.




28 I Nepal Country Economic Memorandum
Finally, household social standing and caste/ethnicity also affect migration and destination patterns
(Adhikari, Rai, Baral, & Subedi, 2023). The economic cost of migration does not vary by caste/ethnic groups
(Kharel, Bhattarai, & Tumsa, 2023a) nor by the location of the origin community. However, Factors that reflect a
household’s social standing, such as the highest adult education, are strong predictors of the destination choice
(Shrestha M. , 2017b). Similarly, historical legacies perpetuated through social networks affect the migration pat-
terns of different ethno-caste groups (Williams, et al., 2020). For example, the high-caste Brahmins and Chhetris,
which exhibit higher income, education, and better social networks, have higher migration to premier destinations.
On the other hand, the lack of migration history and culture among the Terai Janajati discourages their out-mi-
gration altogether (Williams, et al., 2020). These findings imply that in addition to migration costs, non-pecuniary
factors also act as barriers to higher-return migration for poorer and certain population segments.

Figure 2.11. … and it has important implications both on the frequency and amount of remittance migrants
send home.
                              8                                                                                                   800
  Prob bilit nd fr qu nc of




                              7                                                                                                   700




                                                                                                                                        P r mi r nt r mitt nc
                              6                                                                                                   600




                                                                                                                                               (NPR, 1000)
      s ndin r mitt cn




                              5                                                                                                   500
                              4                                                                                                   400
                              3                                                                                                   300
                              2                                                                                                   200
                              1                                                                                                   100
                              0                                                                                                   0
                                   1            2       3        4        5          6      7         8        9        10
                                                                      W       lth d cil
                                         Prob bilt of s ndin r mitt nc                          Fr qu nc ov r th l st 12 months
                                         P r mi r nt r mitt nc (NPR, 1000)


Figure 2.12. Remittances are primarily used for daily consumption and repaying loans.

                         D il consumption
                                  Educ tion
 Hous /l nd/oth r ss ts
             Busin ss/inv stm nt
                                       S vin s
                                  R p     lo n
                                        Oth r

                                                    0       10       20        30         40       50              60        70                   80
                                                                          Sh r of r mitt nc s ndin mi r nts
                                                                                 First us   S cond us

Source: World Bank Staff estimates using the NLSS 2022/23 data.
Note: Figure 2.12 presents the share of migrants by usage of their remittance by their families at home.


Household use of remittances from family members abroad primarily revolves around daily consumption and
repaying loans (Figure 2.12). Most migrants (70 percent) send remittances primarily to support their family’s daily
consumption. Given high migration costs and Nepali workers relying on high-interest loans to finance their moves, it
is not surprising that almost one-fifth of migrants send remittances to repay their loans. While educational invest-
ment is the most cited secondary use of remittances, daily consumption and repaying loans are as prominent. This



                                                                                            Nepal Country Economic Memorandum I 29
may reflect that remittances are not large enough for many households to support beyond their basic expenditures,
and low-skilled migration remains primarily a survival strategy rather than an investment. It may also partially
explain the extremely low take-up of the government’s saving instruments to channel private remittances into de-
velopment investment, such as investment the Foreign Employment Savings Bonds (FESB).20


2.3.	During migration: The benefits for migrant-sending
communities and households

2.3.1.	 Remittances strengthen household resilience and affect migrants’
home-communities
International labor migration remains the key driver of progress on living standards and poverty reduction
in Nepal. Remittances directly contributed to over 30 percent of the poverty reduction observed between 2011 and
2023. This is in line with the historical role migration and remittances have played, having accounted for 27 percent
of the poverty reduction between 1995 and 2010 on the national level and 33 percent in rural areas (Tiwari, 2016).21

Incomes from abroad contribute significantly to sustaining household expenditures and increasing overall
consumption. They benefit households across the consumption distribution, especially when compared to house-
holds in the neighboring countries (Figure 2.13). In 2023, a Nepali household, on average, was likely to receive more
than 20 percent of its expenditure from remittances. This is almost three times higher than the average household
in the regional peer countries. Remittances ranged from 17 percent of household expenditure among the bottom
quintile to nearly 25 percent among Nepalis in the richest quintile. Moreover, fueled by remittances, Nepali house-
holds experienced over a 65 percent rise in consumption during the last decade. The average per-person consump-
tion expenditure increased by 66 percent between 2011 and 2023. This is more pronounced for the households at
the bottom of the expenditure distribution (Figure 2.14). While it increased by 71 percent for the bottom 40 percent,
consumption expenditure among those in the top 6 deciles increased by 68 percent.

Figure 2.13. Financial flows from migrants abroad                                                   Figure 2.14. Household expenditures have improved
account for significantly more of Nepali households’                                                across the distribution.
finances across the distribution than their peers in                                                	
the region.
                                                                                                    % ch n in hous hold consumption




                               30                                                                                                     80
R mitt nc s s % of hous hold




                               25                                                                                                     70
                                                                                                         b tw n 2011 nd 2023




                               20
                               15                                                                                                     60
       consumption




                               10                                                                                                     50
                                5                                                                                                     40
                                0
                                                                                                                                      30
                                      N tion l


                                                 Q1 - Bottom




                                                                        Q3


                                                                               Q4
                                                                 Q2




                                                                                         Q5 - Top




                                                                                                                                      20
                                                                                                                                      10
                                                                                                                                      0
                                                               Consumption quintil s                                                       1   2   3     4   5   6   7     8   9 10
                                                                                                                                       (poor st)                                (rich st)
                                    B n l d sh                    Bhut n               N p l
                                                                                                                                                       Consumption D cil
                                    P kist n                      Sri L nk

Source: Figure 2.13, World Bank staff estimates using Bangladesh’s 2022 HIES, Bhutan’s 2022 BLSS, Pakistan’s 2018 HIES, Nepal’s 2022/23
NLSS, and Sri Lanka’s 2019 HIES; Figure 2.14, World Bank staff estimates using the NLSS 2022/23 data. 	




30 I Nepal Country Economic Memorandum
Figure 2.15. Remittances from a member abroad are strongly linked with human capital investments.
                                       P r c pit duc tion                    P r c pit h lth
                                          xp nditur (lo )                     xp nditur (lo )
                              .06


                              .04


                              .02


                                0
                                    P r c pit r mitt nc s (lo )       P r c pit r mitt nc s (lo )

Source: World Bank Staff estimates using the NLSS 2022/23 data.
Note: Each column is a separate regression model. Controls used in the OLS regressions are household head’s caste/ethnicity, highest adult edu-
cation in the household, household size, log of road distance of municipality from Kathmandu, Urban/Rural status of municipality, and province
fixed effects. Standard errors are clustered at the primary sampling unit (PSU).


Remittances are associated with increased investment in education and health (Figure 2.15). There is a strong
positive correlation between the amount of remittances from family members living abroad and non-food expenses,
particularly on education and healthcare. Controlling for a host of other characteristics, a one percent increase in
per capita remittances is associated with a 0.04 and 0.02 percent increase in per capita education and health ex-
penditures. These findings are particularly significant given the track record of migration and remittances leading to
positive educational outcomes in Nepal, particularly for girls (Shrestha M., 2017a).

Table 2.1. Local labor market spillovers

                                                 LABOR              EMPLOYED                          PARTICIPATION IN
                                               FORCE PAR-
                                               TICIPATION                              Agriculture        Manufacturing          Services

                                                                                All working age (15-64)
 Municipality migration rate                      0.326**             0.304**             0.0728               0.0440              0.185*
 X no international migrant in HH
                                                   (0.138)             (0.140)            (0.0754)              (0.101)          (0.0966)
 Municipality migration rate                     -0.683***           -0.823***             0.0157            -0.358***           -0.480***
 X international migrant in HH
                                                   (0.142)             (0.140)            (0.0718)            (0.0940)            (0.0946)

 Observations                                      23,981              23,981             23,981               23,981              23,981
 R-squared                                          0.142               0.141              0.034                0.043               0.164
 Number of clusters                                  800                 800                800                  800                800
                                                                            Female working age (15-64)
 Municipality migration rate                       0.289*              0.266*             0.0969              0.00445              0.165*
 X no international migrant in HH
                                                   (0.155)              (0.151)           (0.0731)            (0.0972)            (0.0951)
 Municipality migration rate                      -0.290*            -0.483***           -0.00539               -0.119           -0.357***
 X international migrant in HH
                                                   (0.149)             (0.140)            (0.0725)             (0.0910)           (0.0904)




                                                                                     Nepal Country Economic Memorandum I 31
                                                 LABOR              EMPLOYED                          PARTICIPATION IN
                                               FORCE PAR-
                                               TICIPATION                              Agriculture        Manufacturing           Services

 Observations                                      13,586              13,586              13,586               13,586             13,586
 R-squared                                          0.112               0.110              0.037                0.026               0.139
 Number of clusters                                  800                 800                800                  800                800
                                                                             Male working age (15-64)
 Municipality migration rate                        0.262               0.248             0.0683             -0.000901              0.176
 X no international migrant in HH
                                                   (0.186)             (0.190)           (0.0943)               (0.160)            (0.150)
 Municipality migration rate                     -0.607***           -0.768***            0.0905              -0.327**           -0.537***
 X international migrant in HH
                                                   (0.201)             (0.203)           (0.0948)               (0.159)            (0.153)

 Observations                                      10,395              10,395              10,395               10,395             10,395
 R-squared                                          0.174               0.169              0.038                0.087               0.173
 Number of clusters                                  800                 800                800                  800                800
 Source: World Bank Staff estimates using the NLSS 2022/23 and the 2021 Population Census data.
 Note: Estimates do not include subsistence activities as labor market activities and migration rates are expressed in percentages. Controls
 used in the regressions are years of education, age, age squared, household head’s caste/ethnicity, highest adult education in the household,
 household size, log of road distance of municipality from Kathmandu, Urban/Rural status of municipality, and province fixed effects. Standard
 errors, clustered at the primary sampling unit (PSU), are reported in parentheses. *** p<0.01, ** p<0.05, * p<0.1.


Estimates also suggest that high rates of international migration at the municipal level are linked to greater labor
market participation of adults from non-migrant households (Table 2.1). A one percentage point increase in the rate
of international migration in a municipality is associated with a 0.33 percentage point increase in the labor force
participation rate and a 0.30 percentage point increase in the employment ratio among adults from non-migrant
households. This is primarily driven by the increased participation of working-age females from non-migrant house-
holds in the service sector.

On the other hand, the local-level migration rate is negatively correlated with the labor force participation of
adults from migrant-sending households (Table 2.1). When not accounting for subsistence agricultural activities,
a high out-migration rate is associated with reduced labor force participation and employment ratios of both male
and female adults from migrant-sending households. As explored in Phadera (2019) and Lokshin & Glinskaya (2009)
in the context of Nepal, labor supply of left-behind adult members may decrease due to increased leisure consump-
tion resulting from higher income through remittances. A more plausible reason in the context, especially for women,
is that the remaining household members may take on more household responsibilities likely to compensate for the
roles vacated by the male members abroad (Phadera, 2019).




32 I Nepal Country Economic Memorandum
Table 2.2. Annual earnings for daily wage workers increase with higher migration rates and return on education
is high across migration rates.

                                             LOG (WAGE)          LOG (DAILY WAGE)            LOG (LONG-TERM
                                                                                             CONTRACT WAGE)

                                                                            All
Municipality with high migration rate     0.0701                 0.183**                     -0.0459
                                         (0.0498)                (0.0739)                    (0.0541)
Municipality with low migration rate                 0.101***                 0.0706***                 0.0733***
X Years of education
                                                    (0.00620)                     (0.0100)              (0.00667)
Municipality with high migration rate                0.103***                 0.0802***                 0.0711***
X Years of education
                                                    (0.00650)                     (0.0107)              (0.00735)

Observations                               5,295      5,295       2,380            2,380      2,616       2,616
R-squared                                  0.207      0.206       0.130            0.126      0.246      0.245
Number of clusters                          787        787         641              641        694        694
Difference (High Migration - Low                     0.00201                      0.00954               -0.00220
Migration)
HO: High Migration - Low Migration = 0                0.666                        0.330                 0.627
p-value
HO: High Migration - Low Migration >=                 0.667                        0.835                  0.314
0 p-value
                                                                          Female
Municipality with high migration rate      0.145                0.392***                     -0.0401
                                         (0.0903)                 (0.120)                     (0.117)
Municipality with low migration rate                 0.101***                     0.00138               0.0714***
X Years of education
                                                     (0.0117)                     (0.0232)              (0.0132)
Municipality with high migration rate                0.110***                 0.0429**                  0.0723***
X Years of education
                                                     (0.0122)                     (0.0208)              (0.0142)

Observations                               1,732      1,732        750              750        926        926
R-squared                                  0.266      0.265       0.177            0.165      0.233      0.232
Number of clusters                         633         633         366              366        462        462
Difference (High Migration - Low                     0.00908                      0.0415                0.000856
Migration)
HO: High Migration - Low Migration = 0                0.298                       0.0446                 0.925
p-value
HO: High Migration - Low Migration >=                 0.851                        0.978                 0.538
0 p-value




                                                                 Nepal Country Economic Memorandum I 33
                                                            LOG (WAGE)                LOG (DAILY WAGE)               LOG (LONG-TERM
                                                                                                                     CONTRACT WAGE)

                                                                                                Male
 Municipality with high migration rate                  0.0511                        0.167**                       -0.0591
                                                       (0.0471)                      (0.0685)                       (0.0500)
 Municipality with low migration rate                                0.0649***                        0.0158                      0.0639***
 X Years of education
                                                                     (0.00640)                       (0.0105)                     (0.00784)
 Municipality with high migration rate                               0.0649***                       0.0205*                      0.0600***
 X Years of education
                                                                     (0.00655)                       (0.0116)                     (0.00778)

 Observations                                           3,563          3,563           1,630           1,630          1,690          1,690
 R-squared                                               0.190          0.189           0.127          0.122          0.273          0.272
 Number of clusters                                       766            766            594             594            619            619
 Difference (High Migration - Low                                    -2.94e-05                       0.00473                       -0.00381
 Migration)
 HO: High Migration - Low Migration = 0                                0.995                           0.629                         0.354
 p-value
 HO: High Migration - Low Migration >=                                  0.497                          0.685                         0.177
 0 p-value
 Source: World Bank Staff estimates using the NLSS 2022/23 and the 2021 Population Census data.
 Note: The outcome variables are annual earnings from wage jobs; the survey did not collect information on working time. Nepal’s 753 local
 municipalities are divided into high- and low-migrant-sending areas based on migration rates above or below the median. The sample is limited
 to those with wage employment. Controls used in the regressions are years of education, years of work experience and its squared, household
 head’s caste/ethnicity, highest adult education in the household, household size, log of road distance of municipality from Kathmandu, Urban/
 Rural status of municipality, and province fixed effects. Standard errors, clustered at the primary sampling unit (PSU), are reported in paren-
 theses. *** p<0.01, ** p<0.05, * p<0.1.

High municipal migration rates are also associated with higher wages for daily-wage laborers (Table 2). While overall
and long-term wages do not vary by the level of local migration outflows, daily wages in areas with high migration
rates are 20 percent higher than in low migration areas. This is true for both male and female daily wage workers.
The wage premium is higher for female workers, whose wages are 48 percent higher in municipalities with high mi-
gration rates compared to municipalities with low rates. The difference is less pronounced for male workers, with a
premium of 18.3 percent. Returns on education are high but do not differ by migration rates. One additional year of
education is associated with 10.6 percent higher annual wage earnings in low migration areas and 10.8 percent in
higher migration areas. Education returns are generally higher for long-term contract workers than for daily laborers
and for female workers than male workers.

Controlling for other characteristics, international migration improves the subjective adequacy of household
living standards and resilience to food insecurity (Figure 16). Households with a member abroad are significantly
less likely to report less than adequate family living standards. Similarly, migrant households tend to have less ex-
perience of food insecurity in the past 12 months. They are less likely to worry about not having enough food (2.3
percent), eating less variety of food (2.9 percent), skipping meals (0.6 percent), or running out of food (1.2 percent).
These results align with the established evidence that migrant household members abroad act as insurance for the
household in the context of high exposure to shocks and limited access to formal assistance (Yang & Choi, 2007).
Relatedly, the correlation between the labor income loss during COVID-19 and economic distress was close to zero
for migrant households in Nepal (World Bank, 2021).




34 I Nepal Country Economic Memorandum
Figure 2.16. Adequacy of family’s standard of living and food security.
   F ciliti s l ss th n d qu t for f mil ’s n           d
                                                  R sid nti l f cilit
                                                             Clothin
                                                         H    lth c r
                                                 Childr n’s schoolin
                          Tot l incom ov r th p st on month

   Food s curit
   W r     ou worri d ou would not h v            nou h food to     t?
          W r     ou un bl to       th    lth     nd nutritious food?
                            Did ou       t onl     f w kinds of food?
                                     Did ou h v to skip         m    l?
                 Did ou      t l ss th n ou thou ht ou should?
                             Did our hous hold run out of food?
                               W r       ou hun r but did not       t?
                     Did ou o without            tin for whol d         ?
                                                                            -.1             -.05                 0                 .05
Source: World Bank Staff estimates using the NLSS 2022/23 data.
Note: Coefficient on a household with and without an international migrant indicator and its 95% CI reported in the figure. Each coefficient is
a separate regression model. Controls used in the regressions are household head’s caste/ethnicity, highest adult education in the household,
household size, log of road distance of municipality from Kathmandu, Urban/Rural status of municipality, and province fixed effects. Standard
errors are clustered at the primary sampling units (PSU).




2.3.2.	But migration comes with considerable risks

These economic rewards, however, may be taxing to both the migrants and their families. Much of social and
domestic life in the household is put on hold when young male member/s go abroad temporarily and possibly for
multiple stints (World Bank, 2018). While international remittances have improved investment in child health and
education in Nepal, many children face the prospect of not having both parents present during their formative years.
The absence of a parent may have important emotional and psychological implications for the left-behind children
(Fellmeth, et al., 2018) and may even impact their academic performance (Antman, 2013). Additionally, a growing
body of literature shows mixed evidence regarding the impacts of migration on left-behind members’ non-monetary
outcomes, especially on female members. It can reduce women’s labor participation and increase their agricultural
and unpaid family work (Bossavie, 2023; Lokshin & Glinskaya, 2009; Phadera, 2019; Binzel & Assaad, 2011). Moreo-
ver, it may overburden the left-behind members with extra pressure to take up additional household responsibilities
(Démurger, 2015).

Nepali migrants continue to face considerable health, safety, and legal challenges abroad, including a high
incidence of deaths. The Nepal Labour Report 2022 highlights these critical issues faced by migrants. With in-
creasing numbers of Nepalis going abroad for work, the death toll among migrants has risen. Yearly deaths have
mounted to over 1,000 in recent years, with an annual rate of more than 150 in each of the Gulf and Malaysia des-
tinations (MOLESS, 2022; Kathmandu Post, 2024). Migrants in these destinations endure harsh living and working
conditions without access to healthcare, social protection, and other basic services while facing high occupational
hazards and long working hours. These poor conditions and lack of social support, along with the persistent pressure
to send remittance home, contribute to migrants’ poor mental and physical health (MOLESS, 2022) and can remain
persistent even during old age (Ghimire & Bhandari, 2020).




                                                                                     Nepal Country Economic Memorandum I 35
Contract fraud, particularly during the recruitment phase, and employer exploitation while abroad remain
key concerns. Prospective migrants often encounter contract deception not only about the nature of the job abroad
but false contracts altogether. Most of the complaints filed at the migration resource centers (MRCs) are related to
“cheating” during the pre-departure phase (MoLESS, 2020). While abroad, workers may be misled about the type
of employment, salary, working hours, and their initial contracts not being honored. In addition, many employers
continue to practice withholding travel and legal documents, leaving migrants with no choice but to work for them
and severely restricting migrants’ movements.


2.4.	Post-migration: Remigration and reassimilation in the labor
market

2.4.1.	 Migrants struggle to effectively reassimilate

Most of the migration from Nepal is temporary, with migrants eventually returning to the country. GCC coun-
tries and Malaysia, which absorb most workers, do not offer a path to permanent residence. These temporary peri-
ods typically last several years to a decade or more. Between 2016/2017 and 2022/23, renewal permits accounted
for an average of 40% of total labor permits (Author calculation from FEIMS data). Workers typically spend at least
four years abroad, with the average contract duration being only two years.

The lack of systematic record-keeping of returnees creates a challenge to estimate the extent of return mi-
gration accurately. Efforts to address this issue include the integration of the FEIMS with the Nepali Port, managed
by the Department of Immigration (DOI), to record the number of returning migrants at Tribhuvan International
Airport (MOLESS, 2022), the main international airport in the country. However, it is not clear if the system distin-
guishes between migrants returning for a short holiday period or those who return after completing a contract with
the intention of staying in the country. The latter will require reassimilation into society and systematic reintegration
into the domestic labor market.

Remigration is high and indicates the structural weaknesses in the domestic labor market. In a 2020 World
Bank survey of 2000 returnees in high migration districts across all seven provinces, 40 percent reported migrating
more than once, and 32 percent reported migrating to more than one country, with individuals spending 1.5 years
on average between adjacent migration spells (Sharma, Sherpa , & Goyal, 2020). The high renewal rate of labor
permits is another indication of the challenge. The 40 percent renewal rate presented above is a lower bound esti-
mate of remigration, as many permits that are recorded as “new” in the FEIMS are remigrations. The FEIMS records
remigration for contracts with new employers/or destinations and those issued after the renewal deadline as “new”
permits. Remigration for different employment with a different permit is common as language skills, experience, and
networks gained during previous stints help migrant workers secure better jobs in their next spell - migrant salaries
increase by 12% on average during a permit renewal (Sapkota, Shrestha, & Shrestha 2020).

Returnees face significant challenges in reassimilating into the domestic labor market and returns from
participating in the domestic labor market are lower for returnees. Based on the nationally representative Nepal
Labor Force Survey (NLFS) 2017/18 analysis22, the majority of the returnees were either unemployed (14.3 percent)
or remained out of the labor force (41.5 percent), and even among those with jobs, over 75 percent were employed
in the informal sector (MoLESS, 2020). The figures are even more drastic for younger return migrants. Based on
the same survey, the labor force participation rate of male returnees aged 25-44 was 20 percentage points lower
than non-migrants (Sapkota, Shrestha, & Shrestha, 2021). Even when accounting for potential preference for leisure
among migrants, the trend holds. The same analysis shows that returnees also underperform on other labor market
outcomes, such as employment rate and salary in the first year but are likely to catch up over time. As has been
shown for new labor market entrants (Banerjee & Gaurav, 2018; Duflo, Dupas, & Kremer, 2021), a mismatch between
the expectation and the reality (discussed below) may hold the returnees back in the initial years, but as time passes,



36 I Nepal Country Economic Memorandum
the increased economic compulsion may force them to accept the same jobs. On the other hand, the observed im-
proved labor market indicators over time may simply be because many discouraged returnees remigrate, leaving
mostly those who are able to reassimilate into the domestic labor market.

The difference in labor market outcomes between returnees and non-migrants in the initial years can be
partly attributed to the vastly different skill sets the returnees bring from abroad compared to the demand
of the domestic labor market. Only a fraction of returnees utilize the skills learned abroad. According to the NLFS
2017/18, only 15.1 percent of returnees were employed in the same occupational category as abroad (MoLESS,
2020). Other surveys show that about 25 percent of returnees reported utilizing the skills learned during their work
abroad upon returning (Kharel, Bhattarai, Tumsa, Gupta, & Sen, 2022; IOM, 2021). The migration experience is also
likely to increase reservation wages. Given the undersupply of jobs at the expected higher wages, returning migrants
may be further discouraged from entering the job market.

Thus, returnee preference for self-employment remained high. Among the employed returnees in the NLFS
2017/18, almost half (43.7 percent) were either employers, own account workers, or contributing workers (MoLESS,
2020). Similarly, in a survey of 1,400 returnees conducted in Koshi province, the highest proportion were employed
in self-employment agriculture, mainly farming and plantation (34.9%) (IOM, 2021). These patterns are not unique
to Nepal. For example, in Bangladesh, two-thirds of the returnee migrants work in some form of entrepreneurial or
self-employment activity as opposed to only a third of similarly educated nonimmigrant workers (World Bank, 2023).


2.5.	Looking ahead: Reducing costs, increasing benefits, boosting
long-term growth
Systematic migration management through an inclusive institutionalized system is critical for sustainability
and maximizing the rewards from migration. The government of Nepal has started developing an institutionalized
migration system, as seen in the current governance structure reported in Table A1. However, more should be done to
make migration more affordable and equip future migrants with skills and information to make migration safer and
better remunerative. The system should evolve using current evidence and lessons from other countries. Including dif-
ferent stakeholders, with the current and ex-migrants as key partners, is important for effective migration manage-
ment. Nepal’s current predominantly low-skilled economic migration matches the strong demand at the destination
countries. This provides a basis for designing policies focusing on increasing benefits and reducing migration costs
(World Bank, 2023) for contemporaneous migrations with an eye for longer-run skill and destination diversification.

Incorporating migration as a core set of policies within the country’s development, job, and poverty reduc-
tion strategies will provide a platform to work towards such a system and will have larger benefits that are
shared across the distribution (World Bank, 2023). This will entail reducing costs and increasing benefits in all
three stages of migration, namely before, during, and post-migration. Countries like the Philippines and Bangladesh
are good examples for Nepal to follow.

Addressing the structural issues in the domestic labor market will be important for Nepal to create a vibrant
domestic economy where local opportunities can retain people and/or harness new skills. While improving lo-
cal labor markets will support the reassimilation of returnees, it will also improve opportunities for those left behind
and broaden choices if faced with migration decisions in the first place. If managed effectively, the current migration
and remittances-based model can contribute to the effort of strengthening local labor markets. Based on the ev-
idence presented in this review, this section provides policy recommendations for different stages of the migration
cycle to enhance benefits and reduce costs. Table 2.3 summarizes the policy actions, which are discussed in detail
in the rest of the section.




                                                                       Nepal Country Economic Memorandum I 37
Table 2.3. Policy recommendations to improve migration outcomes

                                               POLICY RECOMMENDATIONS

                      Recommendation                      Fiscal              Recommendation                 Fiscal
                                                         Impact                                             Impact

                                                     Creating Opportunities
         Expand formal bilateral labor arrangements               Improve monitoring and implementa-         
         and increase awareness of existing ones.          Low     tion of formal labor arrangements and     Low
                                                                   provide effective consular support.
Tier 1




         Include better provisions for worker pro-                Lower the cost of sending remittances.     
         tection and improvement in labor market           Low                                               Low
         outcomes while abroad in formal bilateral
         arrangements.
         Expand affordable financing and information              Improve data on returnees and evidence     
Tier 2




         about destination markets and domestic            Low     of existing policy interventions.         Low
         exit processes in lagging areas and among
         the less well-off.
                                                     Creating Capabilities
         Enhance pre-departure training without                   Understand destination economies and       
         increasing the cost burden to improve mi-         Low     enable reskilling per demand.             Low
         grants’ preparedness.


 Recommendation 1: Expand formal bilateral labor arrangements to new emerging destinations and
 increase awareness of existing arrangements among workers and civil society.

Summary of the issue: Studies have shown some common issues in bilateral agreements that are also relevant to
Nepal and are discussed below. The issues are weak monitoring and enforcement mechanisms; inadequate protec-
tion compared to regulation and market; overlooking gender sensitivity; lack of guarantee of minimum standards
of employment; and malpractices of migration intermediaries; and lack of engagement and consultation with civil
society (Wickramasekara 2006, Go 2007).

Labor permits in Nepal are granted to over 150 countries, but formal bilateral labor arrangements (such as
Bilateral Labor Agreements - BLAs or Memorandum of Understanding MoUs) exist with only a dozen coun-
tries. Out of the top thirteen countries where over 10,000 permits have been issued from 2020/21 to 2022/23, only
7 have formal labor relations. It’s worth noting that Saudi Arabia and Kuwait, which are the second and fifth largest
destinations for Nepali workers, do not have a Bilateral Labor Agreement (BLA) or a Memorandum of Understanding
(MoU) with Nepal. Similarly, emerging destinations like Portugal, Malta, Cyprus, Croatia, Poland, Maldives, and Tür-
kiye, where over 10,000 Nepali workers are estimated to be present, do not have formal bilateral labor arrangements
with Nepal. This lack of formal arrangements may result in informal labor movements, leading to high costs for mi-
grants, making protection and welfare expensive or inaccessible, and preventing the labor market from reaching its
full potential. Increasing awareness of existing bilateral labor arrangements can assist potential migrants in making
informed decisions, while current migrants can seek support when needed. However, knowledge about these formal
bilateral arrangements and the protection they provide remain low among both aspiring and current migrants (Peo-
ple’s Forum for Human Rights, 2021) (The Five Corridors Project, 2021).

How: Nepal should explore expanding formal labor arrangements to emerging destinations. The focus should be
on improving transparency by maintaining an up-to-date repository of all existing agreements, including content
from bilateral labor arrangements in pre-departure training materials and information and communication sources,




38 I Nepal Country Economic Memorandum
and increasing engagement with civil society and other organizations in developing, implementing, and monitoring
bilateral labor arrangements.

Example: The Philippines Overseas Employment Administration (POEA) is tasked with promoting and developing
overseas employment. It regulates and oversees the employment processes that Overseas Filipino Workers (OFWs)
undergo, but its core functions extend beyond this role. As an employment facilitator, the organization monitors
overseas labor markets, conducts marketing missions, and enters into Bilateral Labor Agreements (BLAs) and Mem-
oranda of Understanding (MoUs) with host countries regarding the hiring of OFWs. This also includes participating
in the drafting of both bilateral and multilateral agreements (POEA, 2016). Additionally, the POEA maintains a public
repository of existing BLAs, which includes both land-based and sea-based agreements. The organization fosters
strong connections with non-governmental organizations and workers’ organizations. To further support OFWs, the
Overseas Workers Welfare Administration (OWWA) provides mandatory country-specific, and sometimes skill-spe-
cific, Pre-Departure Orientation Seminars (PDOSs), while the Department of Migrant Workers offers Pre-Employ-
ment Orientation Seminars. These seminars cover standard employment contract terms and work standards as
outlined in the bilateral labor arrangements (OWWA, 2024).


 Recommendation 2: Improve monitoring and implementation of formal labor arrangements based on
 evidence and provide effective consular support abroad.

Summary of the issue: Implementation of the existing bilateral labor arrangement remains weak despite Nepal’s
increased efforts in the last decade. The diplomatic engagement has shown results such as the reversal of a labor
ban for Nepalese in Malaysia in 2018, the “free ticket, free visa” policy requiring employers to bear recruitment costs
to the GCC countries, moving payments through formal banking, and ensuring timely payments by employers,
etc. However, implementation of these policies remains weak. For example, the “free ticket, free visa” policy, the
prohibition on withholding migrants’ passports and other documents by employers, and the availability of free legal
counsel abroad have not been effectively implemented or implemented at all (People’s Forum for Human Rights,
2021) (Pokhrel, 2024).

How: To ensure effective implementation, it is crucial to regularly review and monitor formal bilateral labor agree-
ments. Cachon (2004), Wickramasekara (2006), and Go (2007) identify five key aspects for monitoring and evalu-
ating these processes: efficacy (comparing expectations with results), conformity (verifying if results align with es-
tablished procedures), pertinence (assessing if the agreement meets the needs), efficiency (conducting a cost-benefit
analysis), and impact (evaluating the effect on the system and stakeholders in both origin and destination countries).
Based on the findings from these reviews, negotiations should be initiated to add or amend provisions and improve
implementation measures. It is also vital to enhance the dissemination of information about the agreements to the
public and migrant workers to ensure better implementation.

Examples: The Philippines has established a coordinating oversight body called the Department of Labor and Em-
ployment (DOLE) Committee to enhance the implementation of BLAs for better protection of overseas Filipino
workers. The country also assigns focal points at its embassies overseas to monitor signed MoUs. Similarly, India
has established the Indian Workers’ Resource Centre (IWRC) in various cities in the UAE, Saudi Arabia, and Malaysia,
which have round-the-clock call centers to register grievances, verify job offers, and provide various other supports
to its citizens (Ministry of External Affairs, Government of India, Media Center, 2018).




                                                                      Nepal Country Economic Memorandum I 39
 Recommendation 3: Include better provisions for both worker protection and improvement in labor market
 outcomes while abroad in formal bilateral arrangements (e.g., ensuring labor market flexibility for workers
 abroad).


Summary of the issue: The existing bilateral labor agreements do not adequately address worker protection and
welfare, as well as tools to enhance labor market outcomes at the destination. While these agreements have helped
open up recruitment channels, they fall short in ensuring worker protection and welfare. Additionally, they do not
address factors that can improve labor market outcomes for migrants abroad, such as job mobility, skills certifica-
tion, and recognition (The Five Corridors Project, 2021). Furthermore, despite increased demand for resumption from
destination countries, Nepal continues to ban female workers from traveling abroad for domestic work, severely
limiting their opportunities (Pandey, 2023). It is crucial to improve these formal labor arrangements to ensure access
and protections for all its citizens.

How: Include provisions that improve labor market outcomes for workers, such as ensuring labor mobility, and skill
training and recognition. Open pathways for female migrants in sectors that have been banned due to issues of pro-
tection by including provisions for access and protection in sufficient detail in these agreements and implementing
them rigorously.

Example: The Philippine government emphasizes the inclusion of specific provisions in Bilateral Labor Agreements
(BLAs) to protect women migrant workers. For instance, the 2018 Kuwait-Philippines Agreement on the Employ-
ment of Domestic Workers requires that recruitment and employment processes follow a standard contract. The
agreement imposes legal penalties on employers, domestic workers, and recruitment agencies from both Kuwait
and the Philippines for any violations of the contractual or legal terms. It also prohibits employers from confiscating
the identification documents of domestic workers (ASEAN, 2022). The UAE-India Harmonized Framework for Skill
Recognition and Certification, on the other hand, ensures that the skills of migrant workers align with the demands
of the UAE labor market. Importantly, these certified skills are recognized across various employers and sectors,
allowing for mobility between industries without the need for redundant training or assessments. This enhances job
security and reduces vulnerabilities for migrant workers (Global Forum on Migration and Development, 2023).


 Recommendation 4: Lower the cost of sending remittances.

Summary of the issue: The average transaction cost of sending remittances to Nepal have been on a decline since
2017, with a slight increase between 2022 and 2023 but remain below the global average (The World Bank, 2024).
Access to bank accounts abroad and use of formal channels have also improved. However, Informal channels con-
tinue to be popular, and use of digital modes remain low. Over 20 to 30 percent of all remittances in certain corri-
dors are still sent through informal channels, which provide a price advantage through better exchange rates and/
or faster transfer times compared to formal channels. Limited digital and financial literacy contributes to the low
use of digital channels, and the adoption varies based on gender, digital literacy, income level, and urbanicity (United
Nations Capital Development Fund, 2022). Mobile digital money has the lowest costs compared to other channels,
but its potential growth and availability is constrained by regulations aimed at money laundering and the financing
of terrorism (World Bank, 2023).

How: Promote competition in both the sending and receiving countries and ensuring that migrants and their families
can compare the costs of all the channels available to them is important (World Bank, 2023).

Example: Since its launch in 2007, M-Pesa has transformed financial inclusion in Kenya by allowing users to de-
posit, send, and withdraw funds using their mobile phones. It is highly regarded for its transparency, featuring fixed
transaction fees that facilitate easy cost comparisons with other services (The Star, 2023). Over the years, M-Pesa
has partnered with providers such as Western Union, PayPal, WorldRemit, and Remitly to enable cross-border money
transfers. Today, M-Pesa is widely used by Kenyan migrant workers to send money back home (Velmie, 2024).




40 I Nepal Country Economic Memorandum
 Recommendation 5: Expand affordable financing opportunities and information about destination labor
 markets and domestic exit processes, including costs and formal financing options in lagging areas and
 among the less well-off segment of the population.


Summary of the issue: Despite the significant improvements over the last decade, international migration oppor-
tunities remain unequal regarding information, access, and overall cost to migrate Those in the poorest provinces
of Sudurpaschim and Karnali are still unable to fully reap the benefits offered by destinations beyond India. To find
jobs abroad, many rely on sub-agents, relatives, and friends (International Trade Union Confederation, 2023), which
may provide inaccurate information leading to incorrect expectations. For example, potential migrants from Nepal
overestimate the increase in earnings and mortality risk associated with working in Malaysia and the GCC countries
(Shrestha M., 2020). Additionally, most migrant workers rely on informal loans to finance their moves, facing very
high interest rates (Kharel, Bhattarai, & Tumsa, 2023a). Thus, efforts to expand affordable financing opportunities
and improve the reach of verifiable information on available destinations can help lower costs and increase returns
for potential migrants.

How: The Department of Foreign Employment (DoFE) and the Foreign Employment Board (FEB) have launched
platforms such as the Foreign Job Search (foreignjob.dofe.gov.np) and the Employment Exchange Market (jobs.feb.
gov.np) to enhance transparency in the recruitment process (MOLESS, 2022). The Foreign Job Search platform even
provides links to advertisements posted by manpower agencies in the newspapers that are required by regulations
to obtain labor permits. However, newspapers and these portals are mostly fit for urban and more educated audi-
ences. Therefore, ensuring wider communication and reach to rural and lagging areas will require working with local
governments, utilizing community-based mechanisms such as community-level organizations and volunteers, and
popular media such as radio programs (Ahmed & Bossavie, 2022). Migrant Resource Centers (MRCs) provide this
information to a certain extent, but coverage is limited (38 districts currently). Additionally, the government can ex-
pand financing options and provide gainful access to migration opportunities to the least well-off and lagging groups
and areas through targeted low-interest loans, grants, and incentives to recruitment agencies.

Example: Indonesia’s Ministry of Manpower delivers migration-related services to migrant workers and families at
the village level. The Desmigratif program (Desa Migran Produktif, or Productive Migrant Village, a safe migration
program) provides information services, data collection, education services tailored to villagers’ needs, and economic
activities for returnees and their families. (Ahmed & Bossavie, 2022). Similarly, Bangladesh has established a migra-
tion-focused bank that provides loans to finance the costs of migration (Bossavie, 2023b).


 Recommendation 6: Improve data on returnees and evidence of existing policy interventions by conducting
 a rigorous evaluation of existing policies and interventions for effective labor market reintegration. Focus
 on job matching, recognition of skills learned abroad (sector-specific and soft skills), reskilling per domestic
 labor demand, and promoting entrepreneurship among returnees.

Summary of the issue: The data on returnee migrants remain scarce. The current programs for retraining/reskilling
and promoting returnee entrepreneurship with soft loan remain out of reach for the most, with very few returnees
having information or utilizing them (IOM, 2021). Efficacy of these programs is not obvious since no rigorous evalu-
ations have been done. Unlike job-specific skills, soft skills such as work ethic, time management, and communica-
tion/customer care are highly transferable across jobs in different sectors. These are the skills returnees are most
likely to report improving while working abroad and can be easily applied to jobs in Nepal, particularly in the growing
service sector. Attention to these types of skills remains limited, and a better understanding of which, when com-
bined with industry-specific reskilling, can reduce friction, and improve placements.

How: Evaluate existing programs focusing on labor market re-integration of returnees using monitoring data avail-
able from primary and administrative sources (e.g., Prime Minister’s Employment Scheme and others). Test the
effectiveness of different labor market interventions such as job matching, recognition of skills learnt abroad (sector
specific and soft skills), reskilling per domestic labor demand, and returnee entrepreneurship.



                                                                       Nepal Country Economic Memorandum I 41
Example: The National Reintegration Center for Overseas Filipino Workers (NRCO) offers comprehensive support
services to returning Overseas Filipino Workers (OFWs) to ensure their smooth reintegration into society. As a vital
resource center, the NRCO provides returnee OFWs with information about government programs, legal assistance,
and various necessary services. It offers counseling services, family reintegration programs, and community-based
support networks. One of the NRCO’s key functions is to provide skills development training and workshops on busi-
ness and financial literacy. The center also assists returnee OFWs in accessing employment opportunities through
skills-job matching and encourages entrepreneurial ventures, allowing them to utilize their overseas experience for
sustainable livelihoods at home. Furthermore, the NRCO conducts research on migration trends and reintegration
challenges. The insights gained from this research help enhance its programs and services. The NRCO also collabo-
rates with civil society organizations, the private sector, and local communities to advocate for policies that address
the unique needs and challenges faced by OFWs and their families, ultimately benefiting them.


 Recommendation 7: Enhance pre-departure training with short language, financial planning, and other
 practical skills without increasing the cost burden to improve migrants’ preparedness.

Summary of the issue: Pre-departure orientation training is mandatory for workers seeking a labor permit. How-
ever, the 12-hour course spread over two days has limited efficacy in improving the transition experience of migrants
aboard (Aryal & Kharel, 2023). Many migrants report not having basic language skills when starting their work as
a key impediment (Migration for development, 2023). A recent field experiment demonstrated that implementing a
new module in Pre-Departure Orientation Seminars (PDOS) to enhance financial decision-making increases the like-
lihood of migrant workers having a bank account (Barsbai et al. 2020). Similarly, relative to migrants who received
the standard pre-departure orientation, those who received the improved PDOS generally experienced fewer trav-
el-related difficulties and problems relating to settlement, such as obtaining a social security number and opening
a bank account (Barsbai, 2016).

How: The orientation curriculum has been improved overtime to tailor modules based on the destination, including
aspects of physical safety and mental health. This includes the use of audio-visual aids and electronic attendance
monitors to ensure active participation. However, there is still room for enhancing pre-departure training to keep
them updated with changing rules in destination countries. Additionally, it is important to provide foundational skills
in language, financial planning, and soft skills such as communication and time management. The effectiveness of
these trainings can be improved by involving experienced migrant workers and individuals who work with returnees.

Examples: Bangladesh’s pre-departure training is flexible and can be updated through effective collaboration with
destination countries. It also includes language modules, such as Basic English and Arabic words for care work,
electronic, housekeeping, and construction works, separately (Ministry of Expatriaes’ Welfae and Overseas Employ-
ment, 2014).


 Recommendation 8: Enabling reskilling per demand of destination economies (education and training).

Summary of the issue: Over the recent years, skilling migrants feature as a top priority in government plans and
actions, however, the supply of education and training have not caught up with the demand in the destination mar-
kets. The formal education system lacks flexibility to quickly meet the emerging overseas demands (Sapkota, 2020)
and the availability of technical and vocational education is limited (IOM, 2023). The Vocational and Skill Develop-
ment Training Centre (VSDTC) under MoLESS, and Council for Technical Education and Vocational Training (CTEVT)
under the Ministry of Education, Science, and Technology are two main institutions that provide training but very few
migrants report undergoing any formal skill training prior to a migration episode (World Bank, 2020). Government,
development partners, and other non-governmental organizations recognize the general need to enhance skills of
migrant workers, but the trainings are ad-hoc (IOM, 2023). Combined with the issue of lack of recognition of skills
gained in Nepal in destination countries (IOM, 2023), the efficacy of these trainings remains low. At the same time,
Nepal should evaluate its position relative to countries such as India, Pakistan, Bangladesh, and the Philippines that
have dominated the supply of migrants for semi-skilled professions and try to find sectors in which Nepali migrants



42 I Nepal Country Economic Memorandum
can have a comparative advantage (Froilan T. Malit & Tiwari, 2022). Quality and price competitiveness will be key.
Investing in building the credibility of Nepali migrants and formal recognition of training and education provided in
the country will be vital. This will require a strong bilateral engagement from the government.

How: Nepal should invest in understanding emerging demands in existing and new destinations by improving data
quality and proactively engaging with destination countries. It should work on a mutual skills recognition system.
Improving the language profile of Nepali workers, particularly in English and Arabic, in the immediate pre-departure
phase will be key to enhancing their competitiveness.

Example: The Philippines produces many graduates from over 2000 institutions of higher learning. Their proficiency
in English and training in generic professional skills allow for easy upskilling and deskilling based on overseas de-
mand. Furthermore, the country’s flexible education system and skill recognition of its workers internationally aid
in the ease by which Filipino workers can migrate. The higher education enrollments by disciplines essentially mirror
the demand abroad (Ang & Tiongson, 2023).




                                                                     Nepal Country Economic Memorandum I 43
CHAPTER 3.
Real Exchange Rates, Trade Policy,
and Exports in Nepal
Nepal’s export sector has seen a marked decline in competitiveness over recent decades, with the exports-to-
GDP ratio dropping sharply from over 25 percent in the late 1990s to just 6.8 percent in 2022. Real exports have
stagnated, with key exports across various industries experiencing significant declines. High trade costs, driven
by Nepal’s challenging geography and inadequate infrastructure, have been central to this trend. Nepal ranks
poorly in global assessments of road and air transport infrastructure, and its National Quality Infrastructure
(NQI) is underdeveloped, leading to frequent issues with international trade standards and export rejections.

The analysis presented in this chapter focuses on the effect of macroeconomic factors and domestic and for-
eign trade policies on exports. The real effective exchange rate (REER) has appreciated significantly since 1994,
diminishing export competitiveness, a situation partly driven by the substantial increase in remittances. Do-
mestic trade policies, including high input tariffs and the difficulty in obtaining duty drawbacks, create addi-
tional barriers. Limited trade agreements and the upcoming graduation from Least Developed Country (LDC)
status in 2026 may lead to the loss of preferential market access and higher tariffs in key export markets.

Empirical analysis at the micro level indicates that the appreciation of bilateral real exchange rates (RER) has
had a significant negative effect on Nepal’s export performance, decreasing exports by about 10 percent since
2011. Domestic input tariffs have also negatively impacted exports, lowering them by around 8 percent since
2011. Lower tariffs on and preferential access for Nepali products, on the other hand, had a positive effect on
exports. The findings highlight specifically the barriers faced by smaller exporters, consistent with more severe
challenges from input tariffs, logistics, and compliance with regulations faced by the same firms.

The results of the analysis suggest that authorities should actively manage inflationary pressures to avoid a
further appreciation of the REER, especially by increasing market competition in key non-tradeable sectors
such as transportation and logistics, and aim at channeling remittances into productive, less inflationary uses
than consumption. Improving the duty drawback system and lowering input tariffs would comprise domestic
trade policies that could stimulate exports. Enhancing trade policy to prolong and secure preferential market
access would additionally benefit Nepali exporters.




44 I Nepal Country Economic Memorandum
3.1.	 Introduction
The competitiveness of Nepal’s export sector has declined significantly over the past decades. Nepal’s ex-
ports-to-GDP ratio dropped from over 25 percent at its peak in the late 1990s to just 6.8 percent in 2022. Merchan-
dise exports relative to GDP are particularly low, at around 3.2 percent. Real exports have been declining or stagnant
over this period, driven by a collapse in major export products across industries (Sharma, 2023). These patterns are
remarkable given that GDP and imports have both grown steadily at the same time. Many factors are commonly
discussed in the context of Nepal’s poor export performance, ranging from the landlocked geography and poor
infrastructure to unfavorable trade policy and exchange rate misalignment due to a surge in migrant remittances.

High trade costs are often cited as a critical factor linked to Nepal’s low level of exports. Nepal’s landlocked
and mountainous geography increase both internal and external trade costs. These natural factors are amplified by
poor physical infrastructure. The World Economic Forum’s Global Competitiveness Report 2019 ranked Nepal’s road
infrastructure 120th and its air transportation infrastructure 131st, out of 141 countries. These issues are amplified
by the lack of market competition in the transportation and logistics sector. The presence of numerous syndicates
leads directly to higher trade costs and acts as a barrier to entry (Rajkarnikar, 2010). Nepal ranks in the lowest
quintile globally in market competition in the 2024 B-READY report. Apart from physical infrastructure and mar-
ket competition, the National Quality Infrastructure (NQI) capacity is also low. Nepal underperforms significantly
compared to other countries, including in the South Asia region, on compliance with trade standards such as safety,
standardization, and technical regulations (Arenas, 2016). Nepal’s weak NQI capacity has led to the refusal of several
of its exports and exacerbated already high trade costs.

Macroeconomic and trade policies have presented challenges to exports, in addition to high trade costs. Ne-
pal’s REER has appreciated by roughly 35 percent since 1994, the year the current peg with India was set. The
appreciation of the REER reduces the competitiveness of Nepalese exports and is often linked to the surge in remit-
tance inflows during recent decades. Remittances as a share of GDP have increased from about 2 percent in 2000
to 22.8 percent in 2022, reaching a peak of 27.5 percent in 2015, placing Nepal in the top 10 remittance receiving
countries worldwide, and prompting concerns about a Dutch disease effect. At a micro level, lack of competition
in key non-traded sectors such as transportation and logistics also contributes to higher price levels and inflation.

Nepal’s trade policies create potential barriers to exports. Input tariffs are relatively high, a factor that contributes
to Nepal being the country with the lowest global value chain participation in the South Asia region (Arenas, 2016).
While the government has implemented policies that allow for a duty drawback for exporters, which should at least
partially mitigate the negative effects of input tariffs, there is a perception among the business community that these
can be difficult to obtain in practice. Firms may not be able to rely on drawbacks when making exporting or pricing
decisions in the presence of substantial delays and/or uncertainty about whether drawbacks will eventually be granted.

Securing and taking advantage of preferential market access in other countries is important in view of the
relatively large trade costs. Nepal currently has two free trade agreements (FTAs), a bilateral agreement with India
and the South Asian Free Trade Agreement (SAFTA). The country, however, currently does not have any agreements
with countries outside of the region, a potential limiting factor for exports considering the global proliferation of
FTAs. The only FTA under formal negotiation is a potential Bay of Bengal Initiative for Multi-Sectoral Technical and
Economic Cooperation (BIMSTEC) agreement, whose membership largely overlaps with SAFTA. Apart from FTAs,
Nepal receives Generalized Scheme of Preferences (GSP) tariff benefits from several high-income countries and tariff
preferences from some developing countries such as China. However, the scheduled graduation from Low-Develop-
ing Country (LDC) status in 2026 would cause many of these preferences to expire following a possible grace period
(Pandey et al., 2022). This could lead to a significant increase in the tariffs faced by Nepalese exporters in several
key export markets.




                                                                        Nepal Country Economic Memorandum I 45
The analysis in this chapter focuses on macroeconomic and trade policies and aims to fill the current gap in
empirical evidence on the determinants of Nepal’s export performance, especially at the micro level. The bulk
of this paper focuses on using detailed firm-level customs data – which are available to us for 2011-2015 and 2018-
2021 – to provide evidence on the effects of exchange rates and trade policies, domestic and partner country, on
exports at the firm-level.23 In order to benchmark results of the effect of real exchange rate movements on exports,
the analysis also provides some evidence on the link between remittances and the REER. Due to the lack of sufficient
micro-econometric variation, this chapter focuses on a cross-country panel analysis using countries in South and
East Asia/Pacific regions.


Preview: Real exchange rates and domestic trade policy lowered exports
Firstly, the appreciation of bilateral RERs had a significant effect on Nepal’s export performance. A 10 percent
increase in the bilateral RER decreases exports on average by about 3 percent.24 Given the appreciation of Nepal’s
REER by around 35 percent between 2011 and 2021, this implies that the appreciation accounted for more than 10
percent lower Nepali exports over the same time. The RER effect was stronger for larger firms, but weaker for firms
that are more diversified in terms of their export destinations or export products.

Secondly, domestic input tariffs have negatively affected exports, while lower foreign tariffs on Nepali goods
had a positive effect. Nepal’s domestic input tariffs have accounted for about 8 percent of lower exports between
2011 and 2021. Smaller firms are more affected by domestic tariffs, which could reflect their limited ability to use
duty drawback schemes due to administrative barriers. Not surprisingly, exports from firms in sectors that are
more dependent on imported inputs are more affected by domestic tariffs. Lower foreign tariffs on Nepal, on the
other hand, boost exports, with a 1 percent lower tariff increasing exports by 0.8 percent. Similarly, if the average
foreign tariff increases conditional on the tariff applied to Nepal, exports also react positively. This result highlights
the importance of preferential tariffs and the risks around the loss of preferential market access through Nepal’s
graduation from LDC status.

Firm-level results highlight the significant barriers faced by smaller exporters in Nepal. This is explicit in the
input tariff results, where the negative effects are driven by these firms. The RER and partner tariff results also show
that smaller firms do not seem to be able to expand to take advantage of more positive external circumstances.
This is consistent with smaller firms facing especially severe challenges in the areas of input tariffs, logistics, and
compliance with regulations (e.g. Kharel and Dahal, 2021). The barriers to the growth of small exporters can prevent
the development of successful export industries in the long-run, and so can help explain the overall weakness of the
Nepalese export sector over time.

Finally, the analysis finds a significant effect of remittances on Nepal’s REER. Between 1992 and 2022, the in-
crease in remittances accounted for 16 percent or around half of the increase in the REER. This confirms past results
from Latin American and Caribbean countries (Amuedo-Dorantes and Pozo, 2004) in finding that remittances con-
tributed to a loss of competitiveness. The analysis also explores some potential heterogeneity in this effect across
countries and finds that a lower labor force participation significantly amplifies the negative effect of remittances on
REER. This pattern is quite significant because of Nepal’s low labor force participation (see chapter 1).




46 I Nepal Country Economic Memorandum
3.2.	The effect of bilateral RERs and trade policy on firm-level
exports

3.2.1.	 Overview of firm-level data in Nepal

The analysis studies the effects of bilateral RER, domestic trade policy, and partner countries’ trade policies
on firm-level exports (Box 3.1). It is based on firm-level customs data spanning 2011-2014 and 2018-2021. This is
the first time such analysis has been done for Nepal. The detailed micro data allows to control for a range of poten-
tial confounding factors through the inclusion of detailed fixed effects. The analysis also emphasizes the heteroge-
neity in effects across different types of firms.



    Box 3.1. Empirical Strategy and Data for Firm-Level Analysis

    Regression Model




    Data




                                                                     Nepal Country Economic Memorandum I 47
More exporters did not lead to higher export value or more export destinations
The number of exporting firms increased between 2011 and 2021 (Table 3.1). However, the exports value per
firm (in thousands of US dollars), the average number of export destinations per firm, and the number of (6-digit)
export products per firm all decreased over the same time.

Table 3.1. Firm-level export patterns

      VARIABLES            YEAR       MEAN         MIN       MAX
 Number of firms            2011          1,322          -         -
                            2021         2,037           -         -
 Exports per firm           2011     US$ 1,239           0   76,657
                            2021    US$ 1,039            0   78,110
 Destinations per firm      2011           13.2          1      97
                            2021             7.1         1       31
 Products per Firm          2011           22.6          1     202
                            2021           16.0          1      74

The average bilateral real exchange rate increased substantially over time (Annex Table A1). This is consistent with
the general appreciation in Nepal’s real exchange rate. The input tariffs also increased substantially, driven by sec-
toral composition changes towards higher tariffs on industrial inputs.

Tariffs of partner countries on Nepal are on average lower than the weighted average tariff in Nepal’s desti-
nation market. This is due to the India-Nepal FTA in the case of India and of GSP-type preferences in the case of
some major developed country destination markets. Both variables also changed in a direction more favorable to
Nepal over time since partner countries’ tariff on Nepal decreased while the average tariff in the destination markets
increased.




48 I Nepal Country Economic Memorandum
3.2.2.	Bilateral exchange rates and exports

The bilateral RER has a significant negative effect on exports (Annex Table A2). The estimates imply that a 10
percent increase in the RER is associated with a 3 percent decrease in exports. The results are similar when using
the CPI instead of GDP deflator to calculate price indices (Column 2) and when controlling for the more extensive set
of fixed effects (Column 3)25.

The RER effect is stronger for larger firms (Annex Table A3, Column 1). Large firms are defined as those that
have total exports greater than the median for all firms in the 2-digit industry the same year. The stronger effect on
larger firms could be because small exporters engage less in systematically in export markets but explore them on
an experimental basis. As such, the amount small firms sell externally may be more “random” and less determined
by systematic factors such as exchange rates. For larger exporters, the relationship between changes in their price
competitiveness and export value may be tighter.

The RER effect is weaker for firms that export to more destinations or that export more products (Annex
Table A3, Columns 2 and 3). These two groups include firms with above-median export destinations and products.
A possible explanation is that these firms are more diversified and better able to ride out bilateral RER shocks. They
may not have to cut exports as much on account of short-term fluctuations in exchange rate conditions. These pat-
terns also hold when including all three interactions together (Column 4 shows that the patterns from 1 – 3 continue
to hold when including all three interactions together).

Additional factors may mediate the effect of RERs on exports (Annex Table A4). The RER effect is substantially
larger for exports to India (Column1). The net effect for India (the sum of the coefficients) is about 1.23. While this
difference is statistically significant, one should caveat that this is estimated using relatively limited variation, i.e.,
there are only 9 distinct values of the RER with respect to a specific partner such as India. Column 2 explores the
dynamics of the RER effect. By default, the analysis lags the RER variable by one period. This regression also in-
cludes the 2-year lag and the contemporaneous year values. It shows that the results are driven by the one-year lag,
with the two-year lag and contemporaneous RER effects being very close to zero. This suggests that the effect of a
RER change on exports generally appear in the subsequent year. A weighted least squares (WLS) regression weights
destinations according to their share of total exports (Column 3). This estimate is less precise but implies a larger
magnitude of about -0.42, consistent also with the larger value for India noted in Column 1. While this estimate is
less precise, the weighting makes it a more natural micro analog to the commonly used real effective exchange rate
(REER) measures. Using this estimate, a 30 percent increase in REER could account for almost a 13 percent reduc-
tion in exports.26


3.2.3.	Domestic trade policy and exports

Input tariffs have a significant negative effect on exports, with larger effects when controlling for additional
factors. The regressions in Annex Tables A6-A8 examine the effect of input tariffs on (log) USD exports at that
firm-product-destination-year level. Input tariffs are calculated at the industry-year level using information from
input-output matrices for Nepal as described in Section 2.27

The magnitude of the coefficients implies that a 1 percentage point increase in the input tariff rate for an
industry is associated with a 2 – 4 percent decrease in exports for firms in that industry. For reference, the
average input tariff rate over the sample is about 2.8 percent, though it is important to keep in mind this measure
includes non-tradable inputs for which the tariff rate would necessarily be zero. Given the increase in average input
tariffs of about 3 percentage points over the sample period, these estimates imply that this factor could account
for 6 – 12 percent lower exports.




                                                                         Nepal Country Economic Memorandum I 49
Input tariffs affect smaller firms more than larger ones, possibly due to the latter being able to benefit from
drawback schemes. The regressions summarized in Annex Table A7 interact the average tariff variables with sev-
eral firm characteristics as in Section 3. The negative effect of input tariffs is driven by smaller exporters and the
net effect (i.e., the sum of the two coefficients) is approximately zero for the larger exports (Column 1). This would be
consistent with larger exporters being successfully able to make use of existing duty drawback schemes and smaller
exporters unable to do so. The compliance costs, delays and risks associated with the duty drawback scheme are
hence likely to be a more significant barrier for smaller exporters. A closer look at firm sizes, considering how input
tariffs affect firms at the 25-50th, 50-75th and 75-100th percentile of size relative to the reference 0-25th percentile
category, confirms the drawback argument (Annex Table A8). The implied negative effect decreases for each subse-
quent firm size bin. The firms in the bottom 50th percentile and especially those in the bottom 25th percentile are
the ones which are most affected by input tariffs.

The tariff effect is stronger for firms that export to more destinations or that export more products (col-
umns 2 and 3, Annex Table A8). One explanation for this pattern is that perhaps firms cut more sharply exports
to destinations or of products that are more marginal in response to higher input costs. Column 4 includes all three
interactions together and confirms the sign and significance of the patterns outlined from columns 1-3.

The effect of import competing tariffs, those set on the firm’s industry, is positive on the other hand (Annex
Table A8). This could reflect spillovers across domestic and foreign activities of firms. A higher price in the domestic
market may help a firm to export more in the presence of credit constraints or economies of scale. It is important
to caveat, however, that these estimates would not account for potential general equilibrium effects of tariffs that
may affect negatively impact exports.

Consistent with economic intuition, the effects of input tariffs are amplified for firms that are in industries
more dependent on imported inputs. The analysis also examines whether the input tariff effect is greater for in-
dustries that use a greater proportion of imported inputs (Annex Table A8, Column 3). Specifically, it analyses the
effect of an interaction of input tariffs with an indicator for whether a firm’s industry is in the top half of (lagged)
imported input share. The results confirm that firms in industries that are more dependent on imports are more
affected by input tariffs. Additional analysis of the extensive margin also shows some evidence that input tariffs
reduce the number of products and destinations by firm (Annex Table A9). However, these results do not survive the
inclusion of industry fixed effects and so the evidence of an extensive margin effect is weaker than for the intensive
margin effect examined in Annex Tables A7-A9.

The significant effects for input tariffs are in useful contrast to the results from Defever et al. (2020), who
find that the Cash Incentive Scheme for Exporters (CISE) was ineffective in increasing exports. The CISE provides
cash subsidies to exporting firms and was originally limited to firms exporting to countries other than India. Despite
the considerable fiscal cost, Defever et al. (2020) find that the scheme had very limited effect on exports. Based on
our results here, those fiscal resources may be better directed towards reducing the input tariff burden on exporters.


3.2.4.	Partner country trade policy and exports

High foreign tariff rates applied to Nepal tend to deter exports and vice versa. The regressions summarized
in Annex Tables A10-A12 examine the effect of tariffs applied on Nepalese exports in a destination and the weight-
ed-average tariff for that product in that destination on (log) USD exports at that firm-product-destination-year
level. The applied tariffs are the lowest tariffs available to Nepalese exporters for that product-destination. These
could be MFN tariffs but could also be preferential tariffs (e.g., GSP or SAFTA). The weighted average tariffs are the
trade-weighted applied tariff and would account for the destination country’s MFN as well as any preferential tariffs
on each of its partner countries. The results show that Nepalese exports are reduced by a higher applied rate on
Nepal and increased by a higher (weighted) average tariff rate in the market.




50 I Nepal Country Economic Memorandum
The applied tariff coefficient estimate implies that a 5 percent increase in the tariffs on Nepalese exports,
for example due to a removal of GSP preferences, would lead to a 4 percent decrease in exports. The weighted
tariff estimate implies that a 5 percent decrease in the average tariff rate in a market, perhaps due to a free trade
agreement between the destination country and another major exporting countries, would also lead to 4 percent de-
crease in Nepalese exports. The estimates are broadly consistent across the different controls, though the weighted
tariff result is not significant with the most stringent set of fixed effects (Annex Table A10, Column 3).

The effects of both the Nepal-specific and the weighted tariffs are amplified for larger firms, who account for
the bulk of Nepal’s exports. The regressions in Annex Table A11 interact the tariff variables with several firm charac-
teristics and column 1 shows more pronounced effects for larger firms. This could be because small exporters engage
in less systematic and more experimental participation in export markets. As such, the amount they sell may be
more “random” and less determined by systematic factors such as tariff rates. For larger exporters, the relationship
between changes in their price competitiveness and export value may be tighter. Also, smaller exporters may expe-
rience more difficulty in scaling according to market opportunities, which would be an interpretation like the results
for the bilateral RERs. The net effect for large firms (adding up the respective coefficients) is -1.35 for the tariff on
Nepal and 1.72 for the average tariff. Given that larger firms account for the bulk of Nepalese exports, the aggregate
effect of partner country tariff regimes is more substantial than what is implied by the estimates.

The effect of the tariff on Nepal is not significantly affected by whether the firm exports to many destina-
tions or products. However, the positive effect of the average tariff in that market is both significantly weaker for
firms that export many products or export to many destinations. A possible explanation is that firms exporting
many products and destinations do so precisely because their exports are less sensitive to competition.

The positive effect of average tariffs on Nepal’s exports may be driven by preferential market access (Annex
Table A12). The effect of average tariffs is more pronounced when also accounting for the tariff margin, i.e., whether
the Nepalese tariff is lower than the average tariff rate in the market, equal, or higher. The results imply that the pos-
itive effect of average tariffs is driven by cases where Nepal is enjoying a preferential benefit (Column 1). The positive
effect of the average tariff is significantly amplified for agricultural and homogenous goods according to Rauch’s
(1999) definition (Columns 2 and 3). These results are consistent with greater price sensitivity for agricultural and
homogeneous goods more generally.

A lower applied tariff on Nepal for a given average tariff rate induces more Nepalese firms to export to this
market (Annex Table A13). Also consistent with the earlier results, a higher average tariff rate in the market induces
more exports by Nepalese firms as well. The coefficients on these extensive margin effects are smaller than the
above discussed intensive margin effects, although robust to the inclusion of additional fixed effects.

Finally, the results presented throughout sections 3.2.2 – 3.2.4 are robust to the inclusion of RER, domestic
trade policy, and partner trade policy variables together (Annex Table A5, Columns 2-3).




                                                                        Nepal Country Economic Memorandum I 51
3.3.	The effect of remittances on REER dynamics
This section examines the effect of remittances on the REER using a panel of low and lower middle-income
countries in South and East Asia spanning 1992-2022. The sample comprises of 15 countries.28 The methodol-
ogy used is similar to Amuedo-Dorantes and Pozo (2004), who examine the effect of remittances on the REER with
a panel of 13 Latin American and Caribbean countries (Box 3.2).



    Box 3.2. Empirical Strategy and Data for Panel Data Analysis




    Data




The growth rates of REER and remittances per capita were higher in Nepal than in most other countries. Table
2 summarizes the basic descriptive statistics for the key variables in the sample as well as the values for Nepal spe-
cifically. In addition to faster REER and remittances growth, Nepal’s labor force participation is substantially lower,
and is in fact the lowest among all countries in the sample. Since this is a panel with a relatively small number of
cross-sectional entities compared to the number of years, it is necessary to ensure that the regression variables are
non-stationary. Using the Im-Pesaran-Shin test for panel data allows to reject non-stationarity when the variables
are first-differenced. The analysis therefore relies on a first differenced version of the model throughout. Finally, all
the independent variables are lagged by one period relative to the dependent variable (i.e., REER) to reduce simulta-
neity concerns.




52 I Nepal Country Economic Memorandum
Table 3.2. Mean values for regression variables

         VARIABLE               ALL COUNTRIES           NEPAL
 REER                                      110.000        102.000
 REER (log change)                           0.007           0.010
 GDP/capita                               1411.000       562.000
 GDP/capita (log change)                     0.028          0.030
 Terms of Trade                            106.000         98.000
 Terms of Trade (log change)                 0.005         -0.005
 Aid/Capita                               235.000         136.000
 Aid/Capita (log change)                     -0.016        -0.004
 Remit/Capita                               73.000        118.000
 Remit/Capita (log change)                   0.057           0.124
 Labor Force Part.                            0.611         0.406
 Import Share                                0.425          0.334


Nepal’s low labor force participation rate reinforced the effect of remittances on the REER
Remittances per capita have a significant positive effect on the REER, with an elasticity of 0.0145 (Annex
Table A15, Column 1). This appears to be a small value in magnitude but as will be discussed later, can account
for substantive effects on the REER given the actual level of remittance growth in Nepal. Financial aid had a similar
positive effect on the REER. The terms-of-trade effect is also positive but less precisely estimated. Conversely, there
is no evidence of a significant real GDP per capita effect on REER. Using the change in level of the REER rather than
log as the dependent variable yields comparable results (Column 2). Since the REER series is normalized to 100 for
each country in 2007, this would imply broadly similar results in terms of magnitude.

The effect of remittances on the REER, however, is driven by countries with a low labor force participation
rate (Annex Table A16). Low vs. high labor force participation are defined as below and above the median level
for any given year. The results summarized in Annex Table A16 show that the effect of remittances on the REER is
driven specifically by low labor force participation countries, which have an implied effect elasticity of 0.0232. For
the higher labor force participation countries, the implied point estimate is in fact negative (i.e., 0.0232 – 0.0357),
though an F-test finds that this is not significantly different from zero. Putting together the pieces, this means that
there is no evidence of a positive effect of remittances on REER for high labor force participation rate countries but
a significant effect for low participation rate countries. Low labor force participation means that a country’s labor
supply is limited relative to the consumer base. Put differently, remittance per worker is effectively higher in coun-
tries with low participation for the same level of remittance per capita. Using a continuous variable for labor force
participation rather than a discrete split yields similar results, with a negative and significant interaction between
remittances and labor force participation (Column 2).

The effects of remittances on the REER in Nepal are substantially more pronounced than in peer countries,
due to its low labor force participation rate. Evaluated at Nepal’s labor force participation of about 40 per-
cent, which is the lowest among the countries in this sample, the estimates imply an elasticity of 0.041 (0.108 –
0.40*0.168). By comparison, the effect elasticity for a country with Bangladesh’s labor force participation, about
58 percent, would be 0.011 (0.108 – 0.58*0.168). This is about a fourth of the value for Nepal. Nepal’s labor force
participation is the lowest among the sample of countries, consistently around 0.40, throughout the same period,
even prior to the surge in remittances.



                                                                      Nepal Country Economic Memorandum I 53
Considering other potential mechanisms through which remittances affect the REER yield insignificant re-
sults. Annex Table A17 considers two additional potential mechanisms. The first two columns examine whether the
remittance effects are different for countries with a higher import share. There interaction term, however, is not sig-
nificant, whether using a binary (Column 1) or continuous (Column 2) measure. The point estimates in both cases are
negative, consistent with economic intuition, however. Columns 3 and 4 examine whether the share of labor employed
in the services sector may mediate the effect of remittances on REER, however, again there is no significant evidence.

Using these results, the inflow of remittances may have accounted for almost half of the REER appreciation
observed in Nepal. Nepal’s remittance per capita increases by about 3.61 log points over the sample period. Using
the estimate that ignore heterogeneity based on labor force participation rates (Annex Table A15), this would trans-
late into a REER increase of about 5 percent. Accounting for Nepal’s very low labor force participation rate (Annex
Table A16), the observed remittance growth would account for about a 16 percent increase in REER. The actual REER
appreciation over this sample period was roughly 35 percent. Hence, based on these estimates, remittances could
account for almost half the REER appreciation observed in Nepal. These estimates imply that the REER appreciation
would have been much more modest if Nepal’s labor force participation were closer to peers, for example Bangladesh.

The model applied in this section can also be used to estimate the REER misalignment. This analysis is pre-
sented in Annex 3.2. As detailed in that appendix, there is evidence of a REER overvaluation but the estimated is
modest when compared to past estimates.


3.4.	Looking ahead: Policy recommendations to boost exports
The analysis presented in this chapter finds evidence that RERs, domestic input tariffs, and partner coun-
tries’ trade policies are all significant determinants of Nepalese export patterns. Estimates imply that the ob-
served increase in the real effective exchange rate in Nepal over the past few decades accounts for about 10 percent
lower exports. The current input tariffs would account for about 6 – 12 percent lower exports. Finally, preferential
trade policy partners towards Nepal from partner countries would account for about 3 percent higher exports. In
addition to the firm-level analysis of exports, the chapter also provides evidence linking remittances to a RER appre-
ciation using a panel of developing countries in South and East Asia/Pacific. The estimates from this analysis imply
that the remittance surge over time could account for about half of the increase in Nepal’s REER.




54 I Nepal Country Economic Memorandum
Table 3.3. Policy recommendations to boost exports

                                                   POLICY RECOMMENDATIONS

                    Recommendation                      Fiscal                 Recommendation                       Fiscal
                                                       Impact                                                      Impact

                                                     Creating Opportunities
         Improve market competition in key                       Develop and promote remittance-linked               
         non-tradable sectors.                           Low      financial instruments for productive in-           Low
                                                                  vestment and household savings.
         Substantially revise or eliminate the Cash Generates Strengthen trade diplomacy and invest-                  
         Incentive Scheme for Exporters (CISE).      Revenue ment promotion by leveraging diplomatic                 Low
                                                              missions.
Tier 1




         Improve trade and quality infrastructure.        
                                                         Low
         Revise the current input duty draw-                     Develop a strategy to gradually compress           
         back systems, particularly from small          High      and rationalize input tariffs and com-            High
         exporters.                                               pensate revenue loss with less distorting
                                                                  instruments.
         Sharpen the monetary policy framework         Indirect   Initiate a dialogue about the suitability of     Indirect
         with a view of containing inflation.          Effects    the current peg.                                 Effects
Tier 2




         Develop a strategy to replace excise            
         taxes designed as de-facto tariffs with        High
         less distorting instruments.


 Recommendation 1: Improve market competition in key non-tradable sectors such as logistics and
 transportation.


 Recommendation 2: Sharpen the monetary policy framework with a view of containing inflation, for
 example through the harmonization of domestically regulated prices.


 Recommendation 3: Initiate a dialogue about the suitability of the current peg.
Summary of the issue: The REER effects imply that policies to manage inflationary pressures would help Nepal’s
export performance. Given the Nepalese rupee’s peg to the Indian rupee, Nepal’s bilateral real exchange rate with
India will mechanically appreciate when inflation is higher in Nepal than in India. Since the Indian rupee’s nominal
values vis-à-vis other currencies will be linked to inflation in India, this will also indirectly translate into appreciation
of Nepal’s real exchange rate with respect to other trade partners. Nepal’s annualized inflation in the decade to
2022 has exceeded India’s by about 2 percentage points. While the costs of inflation to consumers have been sali-
ent across the world in recent years, including in Nepal, the results point to the value of managing inflation from an
exporter perspective as well. Beyond limiting high inflation, if Nepal can maintain an inflation rate lower than India’s
for some time, this would over time reverse the overvaluation of Nepal’s real exchange rate.

Tackling distortions in the non-tradable services sector, managing episodes of inflationary pressures through
monetary policy and initiating dialogues about potential alternatives to the current peg can be gradual ap-
proaches to addressing the loss of price competitiveness. While Nepal’s inflation rate is mechanically connected
to India’s, the very fact that the inflation differential has been sufficiently large and sustained to cause a REER ap-
preciation shows that Nepal does have some potential policy space in this area. In addition, economic fundamentals




                                                                          Nepal Country Economic Memorandum I 55
evolve and the current peg, while providing some stability, may not align anymore with current macroeconomic
conditions, particularly since inflation differentials and trade imbalances persist.

How: Reduce distortions in key non-tradable sectors to mitigate and reverse the effect of adverse price trends in
Nepal. Remove the pervasive presence of syndicates in transportation (e.g. trucking), logistics, and distribution that
contribute to higher prices and barriers to entry. Increased use of digitization at customs points and removing dis-
tortions in the provision of digital utilities (discussed more in Chapter V) would also contribute to reducing price levels
and inflation. Apart from reducing price levels, in the absence of improvements in logistics and transportation, other
policies to encourage exports will be much less effective. Sharpen the monetary policy framework with an emphasis
on the fact that inflation, especially more than India’s, can exacerbate the overvaluation of the exchange rate and
substantially hurt the export sector. Conduct a joint dialogue led by the Ministry of Finance and Nepal Rastra Bank
to assess whether the currency peg remains appropriate considering evolving macroeconomic fundamentals, or
if the medium-term competitiveness benefits of a crawling peg would outweigh potential short-term inflationary
pressures. A key aspect of this dialogue should be to brainstorm external circumstances under which moving from a
peg could be potentially more attractive and politically feasible (e.g. during a more deflationary global environment).

Example: Botswana and Cambodia in the early 2000’s provide examples of tackling inflationary pressures in the
context of a pegged exchange rate. Singapore is another country that implements effective policy with a managed
floating exchange rate.


 Recommendation 4: Develop and promote remittance-linked financial instruments, including remittance-
 backed credit for productive investment and remittance-linked household savings instruments.

Summary of the issue: Remittances have contributed to the appreciation of the REER. The bulk of remittance
income in Nepal is spent on basic consumption and on repaying expensive migration loans (see Chapter 3). But
channeling part of remittances into more productive investment could help offset the negative effect of remittances
on the REER and exports.

How: Create and promote investment vehicles for remittance income and savings in general. This could encourage
channeling of income towards capital formation and less inflationary uses more broadly.

Example: Mexico’s 3x1 program for migrants leverages remittances to fund development projects in migrants’
hometowns, enhancing local development and creating jobs. Philippines Overseas Workers’ Welfare Administration
(OWWA) programs offer investment opportunities in addition to diaspora bonds offered by the government.


 Recommendation 5: Revise the current input duty drawback systems with a view of lowering
 administrative burdens and increasing firm uptake, particularly from small exporters.


 Recommendation 6: Develop a strategy to gradually compress and rationalize input tariffs, starting with
 raw materials and intermediate inputs, and compensate revenue loss with less distorting instruments.


 Recommendation 7: Develop a strategy to replace excise taxes designed as de-facto tariffs with less
 distorting instruments.




56 I Nepal Country Economic Memorandum
 Recommendation 8: Substantially revise or eliminate the Cash Incentive Scheme for Exporters (CISE).


Summary of the issue: The results on the adverse effect of input tariffs imply the need for improvements in the
current duty drawback systems, especially targeted towards smaller exporters. While the government has imple-
mented an input drawback scheme for exporters, results show that, consistent with the perceptions in the business
community, this system has not neutralized the input tariff burden on exporters. This is particularly the case for
smaller firms, who face a greater administrative burden in connection with the existing scheme. While larger export-
ers tend to account for the bulk of a country’s exports at a given point in time, smaller exporters play a crucial role
in experimenting and engaging in the discovery of a country’s comparative advantage. Factors that affect their sur-
vival could have significant effects in creating large and successful exporters in the future. Beyond drawbacks and
exemptions, there would be additional benefit from a reduction in input tariffs. This would have a larger fiscal cost,
although not necessarily prohibitive according to some studies (e.g., Narain and Varela, 2017), but offer other advan-
tages. It would reduce the costs of inputs that a firm does not directly import but sources through other domestic
firms that ultimately depend on imported inputs. A reduction in input tariffs would also help producers selling in the
domestic market. Given Nepal’s low current level of exports, this would have a larger aggregate productivity effect.

How: Improve the input rebate system by ensuring that drawbacks are provided in a more prompt and complete
manner could be an important part of reducing barriers to the growth of small and medium enterprises. Schemes
that allow exporters to be exempted from customs duties, such as the proposed Revised Customs Act approved by
Cabinet in 2023, could be one step in this direction. Consider as a complement to an improvement in the input draw-
back or exception schemes to directly reduce input tariffs. Reducing input tariffs would be administratively simpler
compared to improving the input rebate system. Improving the rebate system and reducing input tariffs on some
products could be policies that go together rather than being alternatives. Addressing the high input tariff burden
would be a more effective use of fiscal resources than the current CISE, which has been found to be ineffective at
increasing exports despite its considerable fiscal cost (Defever et al., 2020).

Example: India took steps to rationalize tariffs and improve duty drawback systems through the Duty Drawback
Scheme and Remission of Duties and Taxes on Exported Products.


 Recommendation 9: Strengthen trade diplomacy and investment promotion by leveraging diplomatic
 missions to pursue additional FTAs and extend LDC preferences.


 Recommendation 10: Improve trade and quality infrastructure by fully implementing fiscal federalism and
 aligning infrastructure planning across government tiers.

Summary of the issue: Efforts to extend LDC preferences could help to reduce or reverse potential negative effects
of Nepal’s LDC graduation on exports, particularly those of larger firms. Nepal currently benefits from LDC prefer-
ences in several destinations that are set to expire in 2026 or after some subsequent grace period. In the long run,
Nepal could benefit from pursuing preferential trade agreements with countries outside of the region. Apart from
increasing the total level of exports, this could also help diversify export destinations since about 80 percent of Ne-
pal’s exports currently are to India. Diversification of this nature was an explicit goal in the original CISE too, which
however was ineffective. Since the composition of demand and domestic production in India will be different from
other destination markets, market diversification would also increase the scope for product diversification.

In the absence of broader infrastructure improvements, including the NQI, the effects of preferential market
access are likely to be more modest than the effects of addressing the RER appreciation and input tariffs. Ne-
pal’s high trade costs are likely limiting the extent to which exporters can benefit from preferential access. About 80
percent of Nepal’s exports go to India and most of the rest transits through India. Infrastructure that reduces inter-
nal trade costs and connects centers of potential economic activity to the Indian border effectively could therefore
be especially valuable. Since part of Nepal’s trade costs with India and the rest of the world depend on infrastructure



                                                                        Nepal Country Economic Memorandum I 57
in India, recent improvements in Indian road, rail, air, and port infrastructure further increases the potential benefits
from improvements on the Nepalese side of the border. Apart from the direct reduction of export costs, such policies
would also help exporters through reduced input costs, an effect implied by the results on input tariffs. Finally, the
evidence suggests that agricultural exports may be especially responsive to preferential tariff margins. This is an
area where improvement in Nepal’s relatively weak NQI, e.g., better alignment with international quality standards,
could be particularly impactful.

How: Pursue and protect preferential access to foreign markets due to the expected loss of trade preferences from
the upcoming LDC status graduation. One line of negotiation can be emphasizing Nepal’s status as a landlocked de-
veloping country (LLDC). This status may provide foreign countries with flexibility to extend LDC preferences to Ne-
pal without necessarily having to create a much broader precedence that would apply to all recent LDC graduates.
In addition, pursue preferential trade agreements with countries outside of the South Asia region. Finally, reducing
trade costs through improvements in transportation and quality infrastructure will be essential both in general and
in allowing Nepal to take advantage of any available preferential trading terms.

Example: Bangladesh, anticipating its 2026 LDC graduation, has actively engaged in trade diplomacy to extend
preferential market access. The country also worked on improving and expanding trade relations through bilateral
and regional trade agreements with key trading partners. Viet Nam strategically invested in its NQI infrastructure to
boost the quality of its exports and improve market access.




58 I Nepal Country Economic Memorandum
CHAPTER 4.
Unlocking Nepal’s Hydropower
Potential to Enable Stronger Growth
Nepal’s hydropower sector has the potential to enable higher long-term economic growth and reduce the coun-
try’s reliance on foreign energy sources. With an estimated capacity of 83,000 MW, of which 42,000 MW is
economically viable, the country has only tapped into 4 percent of this resource. Hydropower can provide clean
and reliable electricity, boost productivity across industries, attract foreign investment, and enable Nepal to
export surplus electricity to neighboring countries like India and Bangladesh. This could generate substantial
foreign exchange and enhance Nepal’s role in regional energy trade.

To realize these benefits, Nepal must address several critical challenges that currently hinder progress. These
include underdeveloped infrastructure, limitations in transmission and distribution network capacity, cli-
mate-related risks, and financing hurdles. National electricity supply remains unreliable, and many firms face
frequent power outages, impacting their operations and profitability. Bureaucratic inefficiencies, an outdated
legal framework, and difficulties in securing financing, particularly from foreign investors, further complicate
sector development.

Recent progress has demonstrated Nepal’s potential. In 2024, the country became a net exporter of electricity
for the first time, driven by the completion of several larger-scale hydropower projects. However, to meet the
government’s ambitious goal of installing 28,500 MW of electricity capacity by 2035, further reforms and sub-
stantial investments will be necessary. Enhancing cross-border electricity trade, improving grid infrastructure,
and developing smart grid technologies will be essential to support this growth.

The private sector will play a crucial role in this expansion, currently accounting for over 70 percent of newly
installed capacity. Encouraging private investment through clear policies, transparent processes, and improved
access to financing will be key to unlocking the sector’s potential. Moreover, strengthening the legal and regu-
latory framework, addressing infrastructure bottlenecks, and ensuring effective risk mitigation strategies for
investors can attract the capital needed to advance large-scale projects.

While hydropower offers significant benefits, it is not a quick fix for Nepal’s energy and economic challenges.
The sector’s growth will be gradual, and the benefits will be fully realized over the long term. Hydropower is not a
labor-intensive sector, with most job opportunities arising during the construction phase or in related industries.
As a result, hydropower’s direct contribution to job creation is modest compared to other sectors, like tourism.
Nevertheless, if managed well, hydropower can become a cornerstone of Nepal’s development strategy, provid-
ing energy security, generating export revenue, and laying the foundation for sustainable economic growth.




                                                                    Nepal Country Economic Memorandum I 59
4.1.	 The current state of Nepal’s hydropower sector
Hydropower production has increased, but remains well below its potential
Hydropower is one of Nepal’s most important natural resources, with an estimated potential of 83,000 MW,
one of the highest in South Asia. Nepal’s geography, with its towering mountains and fast-flowing rivers, makes it
an ideal location for hydropower development. The country’s major rivers, including the Koshi, Gandaki, and Karnali,
flow down from the Himalayas, providing a hydropower potential of 83,000 MW, of which 42,000 are considered
economically viable.

The government has long identified hydropower as a cornerstone of the economy. Hydropower has been seen
by governments as a cornerstone of economic growth and a pathway to energy independence and energy secu-
rity. In addition to meeting domestic electricity needs, Nepal’s strategic location between India and China, the two
largest energy markets in the region, positions it to benefit from regional energy trade, where it can leverage its
hydropower potential for economic growth.

But despite the ambitions of several governments, Nepal’s hydropower potential remains vastly underuti-
lized (Figure 4.1). As of 2024, only 4 percent of hydropower resources have been harnessed, around 3,000 MW
out of the potential 83,000 MW.29 Among peers in the South Asia region, only Bhutan has similarly limited installed
hydropower capacity compared to its potential, around 8 percent. Pakistan and India, on the other hand, have
exploited their potential more effectively, having installed 17 percent and 29 percent of their hydropower potential.

Figure 4.1. Hydropower potential and installed                       Figure 4.2. Components of overall domestic energy
capacity in MW                                                       production in 2022 in percent of total.

        160,000
        140,000
        120,000
 w tt




        100,000
        80,000
 M




        60,000
        40,000
        20,000
             0
                     Indi     P kist n     Bhut n        N p l
                             Pot nti l       Inst ll d                   Co l    H dro     Wind, sol r, tc.   Biofu ls nd w st

Source: Investment Board of Nepal, Ministry of Power India, Agence   Source: International Energy Agency.30
Francaise de Development, Druk Green.


As a result of the slow development of the sector, hydroelectricity accounts for only a small fraction of Ne-
pal’s energy production. Hydropower has been the near exclusive source of electricity production in Nepal, ac-
counting for 95 percent. However, the overall domestic production of energy is dominated by biofuels and waste
such as fuelwood, agricultural residual, and animal dung, which accounted for more than 90 percent of the energy
produced in Nepal in 2023 (Figure 4.2). Hydroelectricity, on the other hand, accounted for only 8 percent of Nepal’s
total energy production in 2022. Adding energy imports to the domestic energy production reduces the share of
hydroelectricity even further, to around 6 percent of the total energy supply in Nepal.

Nepal’s electricity production continues to lag that of peers. On a per capita basis, Nepal’s electricity production
amounted to 321 kWh in 2022, significantly less than per capita electricity generation in regional peer countries



60 I Nepal Country Economic Memorandum
(Figure 4.3). By 2024, per capita electricity generation in Nepal has increased to around 400 kWh, still significantly
lower than in peers.

The reliability of electricity supply remains an operational hurdle for many firms, despite the eradication of
scheduled load shedding. Load shedding affected industrial firms between 2007 and 201731 but was eliminated in
May 2018. Frequent power cuts nevertheless continued to affect firms’ operations, with 76 percent of firms still ex-
periencing regular power outages. Accordingly, over one-third of firms highlighted in the 2023 World Bank Enterprise
Survey that the reliability of electricity supply remains an issue for their operations.32 One of the main reasons for
the unreliable supply is the weak and constrained transmission and distribution system, with old and undercapacity
transmission lines, substations, and distribution networks.

Figure 4.3. Per capita electricity generation in 2022                                  Figure 4.4. Installed hydro capacity by Nepal Elec-
                                                                                       tricity Authority and Private Sector in MW33
         12000
                                                                                               3500
         10000
                                                                                               3000
         8000                                                                                  2500
In kWh




         6000                                                                                  2000




                                                                                       In MW
         4000                                                                                  1500

         2000                                                                                  1000
                                                                                                500
            0
                                                                                                 0
                                                                  B n l d sh
                                                       P kist n
                 Bhut n




                                                                               N p l
                          M ldiv s




                                            Sri L nk
                                     Indi




                                                                                                             2018

                                                                                                                    2019

                                                                                                                           2020




                                                                                                                                                       2024
                                                                                                                                         2022
                                                                                                                                  2021
                                                                                                      2017




                                                                                                                                                2023
                                                                                                                       NEA           IPPs
Source: Ember 2024, Energy Institute.                                                  Source: Nepal Electricity Authority.



Unreliable electricity supply had a significant impact on firms’ output and profitability. More than 13 percent of
firms reported losses exceeding 10 percent of their annuals sales due to power cuts in 2022. Down from 38 per-
cent of firms reporting such losses in 2013. As a coping mechanism, firms continue to rely on captive generators,
with 36 percent of firms having used them in 2022 compared to 50.5 percent in 2012.

The uptake in electricity production in recent years gives reason for a more optimistic outlook. Total installed
hydropower capacity more than tripled over the past decade and reached 2,990 MW by the end of 2024 (Figure
4.4). Several larger projects since 2021, including the Upper Tamakoshi project, have boosted hydropower capacity
by nearly 30 percent on average per year, doubling installed capacity between 2021 and 2024. Total electricity pro-
duction reached 12,027 GWh in 2024. The increased production of hydroelectricity led to a reduction in net-imports.
Earnings from exports to India have also increased significantly since 2020, reaching 0.3 percent of GDP in 2024.

The increase in hydroelectricity production reduced Nepal’s seasonal supply and demand gap. Due to the
dominance of run-of-river hydropower, Nepal’s electricity generation peaks during the rainy season (June-Novem-
ber). Demand, however, peaks during the winter/dry season (December-May). Nepal therefore tends to generate
surplus electricity during the rainy season and be in deficit during the dry season. To meet demand during the dry
season, Nepal needs to import electricity. In 2018, Nepal imported nearly 2,582 GWh, amounting to about 37 per-
cent of total electricity consumption, while exporting only about 3 GWh. However, due to added generation capacity,
the supply-demand gap has decreased significantly in recent years. In 2023, the country imported about 1,895 GWh
amounting to about 16 percent of the total electricity consumption, while exporting 1,946 GWh, making Nepal a net
electricity exporter for the first time.




                                                                                                      Nepal Country Economic Memorandum I 61
Hydropower could enable stronger industrial output in the long term. Hydropower is the major component
of the electricity, heat, steam, and air conditioning supply category within the industry sector, which covers the
production and distribution of electricity. Overall, the subsector remains small, accounting for only 1.6 percent of
Nepal’s total economic output in 2024. Developing the sector is a long-term game, but the recent dynamics are
promising. The subsector has expanded by nearly 13 percent on average since 2012. Growth of the subsector was
particularly strong over the past five years, when several bigger projects came online, reaching roughly 22 percent
on average per year.

The private sector has played the leading role in developing Nepal’s hydropower sector over the past years.
Independent power producers (IPPs) have accounted for more than 70 percent of the hydropower capacity added
since 2018. The remaining capacity was installed by the Nepal Electricity Authority (NEA), the state-owned enter-
prise responsible for generating, transmitting, and distributing electricity, and its subsidiary companies. The share
of IPPs in total installed hydropower capacity increased accordingly to 64 percent in 2024, up from 50 percent in
2018. Most of the projects installed by IPPs are run-of-river hydropower plants, which produce less electricity during
dry season and are not able to meet peak electricity demand.

Nepal’s electricity transmission and distribution network has seen improvements in recent years, but chal-
lenges remain. Improvements were driven by increasing domestic generation capacity and the government’s focus on
reducing load-shedding. Improved cross-border transmission links with India have enhanced grid stability and export
potential. However, Nepal’s transmission and distribution infrastructure still suffers from high system losses, outdated
equipment and technology, and limited capacity to transmit and distribute electricity from remote hydropower plants
to urban and industrial centers. Rural electrification is still lagging, with some remote areas relying on unreliable off-
grid solutions. Further investments in transmission infrastructure, smart grid technology, and distribution network
improvements are essential to meet rising demand and ensure reliable electricity access across the country.

On the back of recent promising dynamics, the government has set an ambitious development target for the
electricity sector. Authorities announced their ambition to achieve a total installed electricity generation capacity
of 28,500 MW by 2035. This target would imply a near tenfold increase over the country’s current installed hydro-
power capacity. In comparison, capacity over the last decade increased roughly threefold.

But the current portfolio of hydropower projects, the main source of additional electricity generation, falls
short of the government’s target. Achieving the electricity sector development goal will hinge upon the successful
expansion of the hydropower sector. Particularly IPPs will play a critical role in bringing new hydropower projects
online. As of 2024, however, the pipeline of hydropower projects appears insufficient to reach the electricity target.
Since end-2018, 80 projects with a total capacity of 10,575 MW have applied for a construction license, an activity
that can take more than 5 years until completion.


4.2.	The key impediments to hydropower development
The development of Nepal’s hydropower sector has long fallen short of ambitiously set targets (Figure 5).
Nepal’s hydropower output has significantly underperformed when compared to past projections and ambitions.
When considering Nepal’s last three development plans, only 28 percent of the hydropower capacity targets were
achieved on average. Hydropower development improved during the 15th development plan period, owing to the
operationalization of several large-scale projects. Nevertheless, only 45 percent of the capacity target outlined in
the 15th plan was achieved.

Several bottlenecks have hindered the faster development of Nepal’s hydropower sector. Securing adequate
financing has been a challenge, as hydropower projects require significant capital investment, and Nepal has had
very limited success in attracting foreign investors. The outdated legal framework does not allow for open access to
transmission and distribution and precludes power trading by private entities, hindering the faster development of



62 I Nepal Country Economic Memorandum
the sector. Limited domestic demand and limited network capacity to evacuate power to load centers are further
contributing to this problem. Limited access to the Indian market has further complicated the sector’s develop-
ment. The low quality and reliability of power supply contributed to the lower uptake of electricity as industries and
commercial establishments often prefer to use captive power generation infrastructure, despite their significant
costs. Moreover, environmental concerns and opposition from local communities over displacement and ecological
impacts create resistance and complicate project execution.


Ensuring sufficient financing to develop the sector is challenging
Between 2015 and 2024, Nepal’s public and private hydropower investments amounted to around US$293
million per year on average. Nepal has used a mix of public and private investment to develop the hydropower
sector. The public sector invested on average US$93 million per year since 2015 through NEA and its subsidiaries.34
Public investments include hydropower electricity generation, transmission, and distribution. Private investments
in hydropower targeted electricity generation and amounted to more than US$200 million on average per year.35
Private investments were mainly in the form of build, own, operate, and transfer (BOOT) arrangements.

Public and private hydropower producers have leveraged their investment to an extent. NEA, the public hy-
dropower producer, leveraged resources from institutional investors, for example the large Upper Tamakoshi Hy-
dropower plant was developed with debt and equity investments from the Employees Provident Fund, the Citizen
Investment Trust, Nepal Telecom, and Rastriya Beema Sansthan. Private producers leveraged financing from do-
mestic and foreign financial institutions, plus multilateral and bilateral donors.

Hydropower companies have increasingly relied on the domestic capital market, primarily the equity market.
By the end of 2024, 91 hydropower companies were listed on the Nepal Stock Exchange (NEPSE), the only organized
stock exchange in Nepal, up from 27 a decade ago. These companies represented around 15 percent of market capi-
talization, a significant increase from the 7 percent recorded a decade ago. Public and private hydropower producers
have raised funds through Initial Public Offerings (IPOs) to finance small to medium-sized hydropower projects.

Bond financing, on the other hand, has been a less important factor in financing hydropower projects. While
the government issues longer-term development bonds in addition to Treasury Bills, they are not sufficiently liquid,
and their size is too small to attract institutional investors. Deposits with commercial banks have offered superior
returns compared to development bonds. Authorities have in the past tried to mobilize resources from overseas
workers through remittance bonds, but due to design and marketing deficiencies these bonds were undersubscribed.

Inefficient public investment management and planning has negatively affected the financial viability of hy-
dropower projects. Nepal’s hydropower projects on average take 7 – 10 years to finish, substantially longer than
in other countries, including India. Delays are often exacerbated by bureaucratic hurdles, including lengthy approval
processes, delays in granting permits for clearances, and delays in securing land acquisition. Consequently, potential
investors in Nepal’s hydropower are often reluctant to commit significant capital, given the uncertainties around
project implementation.

Foreign direct investment (FDI) in Nepal’s electricity sector has been limited. The lack of currency risk mitiga-
tion mechanisms, such as US$ denominated power purchase agreements, has negatively affected incentives for
foreign investors to participate in the market. As of 2023, the outstanding FDI stock in the electricity subsector
amounted to around US$ 659 million, around 30 percent of the total outstanding FDI stock in Nepal. India ac-
counted for nearly half of hydropower FDI, China for nearly one-third. India has played an important role in financ-
ing hydropower projects in Nepal. Larger, export-oriented hydropower projects like Arun 3 and Upper Karnali were
financed mainly by SOEs and commercial banks from India.

Achieving an installed Electricity generation capacity of 28,500 MW by 2035 will require a significant scal-
ing up of investment in electricity generation, transmission, and distribution. A World Bank assessment of



                                                                      Nepal Country Economic Memorandum I 63
Nepal’s electricity sector finds that annual investments of US$ 1.2 – 2.1 billion on average until 2040 will be neces-
sary to develop the electricity sector sufficiently. Relative to Nepal’s economy, the necessary annual investments
amount to 3 – 5 percent of GDP. Additional investments of US$1 billion per year may be necessary for the develop-
ment of larger-scale, export-oriented projects.


Market structure and policies have hindered more investment in the sector
In Nepal, the NEA functions as the sole buyer of electricity generated by IPPs. As a vertically integrated utility,
NEA is responsible for both distributing electricity to domestic consumers and trading surplus power across borders,
particularly with India. The bankability of power purchase agreements (PPAs) with NEA depends heavily on the inclu-
sion of take-or-pay clauses, which guarantee that NEA will purchase a fixed amount of electricity even if it cannot
sell it. Without this certainty, financial institutions are reluctant to provide funding to energy projects, making it
difficult for developers to secure financing.

At times, NEA has been reluctant to enter PPAs with IPPs. NEA has been cautious about committing to take-
or-pay contracts on several occasions due to the risk of being left with surplus electricity it cannot trade or sell,
especially during periods of low domestic demand or limited export opportunities. This has led to NEA’s discretionary
approach to opening new PPAs, where it selectively decides when to sign contracts with IPPs. As a result, power pro-
ducers often face delays in securing agreements, which hinders project development and slows the overall growth
of Nepal’s energy sector.

Nepal’s current first-come, first-serve licensing regime for hydropower projects has led to suboptimal alloca-
tion of resources and project delays. This system awards licenses to developers based solely on the order of their
applications, often resulting in projects being granted to those who may lack the necessary financial or technical
capacity to proceed effectively. Consequently, many projects become delayed or remain stalled, preventing Nepal
from fully capitalizing on its rich hydropower potential. Experts argue that this inefficient process not only discour-
ages investment but also leads to a waste of valuable resources that could otherwise contribute to national energy
production and economic growth (World Bank, 2020).

Compounding these issues is Nepal’s outdated legal framework. The Electricity Act of 1992, still in force, is insuf-
ficient to meet the challenges of modern hydropower development and international energy trade. Despite years of
discussions, a replacement law remains stuck in parliament, leaving the sector without a legal basis for key issues such
as tariff setting, cross-border electricity sales, and private sector protections. The delay in passing this new law has un-
dermined higher private investment in hydropower generation. Private investment in transmission and distribution has
not been feasible until late 2024. Investors face uncertainties regarding returns on investment, and the government
has been slow to implement incentives that could make the sector more attractive. Until legal reforms are enacted, the
potential for Nepal’s hydropower industry to enable economic growth and regional energy trade will remain unrealized.​

As a result of policy ambiguity, the sector faces several deficiencies that hinder its effectiveness in facilitat-
ing hydropower development. One significant issue is the slow and cumbersome project approval process, which
often leads to lengthy implementation delays. Bureaucratic hurdles due to unclear regulations and inconsistent
policies create uncertainty for investors. Additionally, the Investment Board of Nepal (IBN) has limited capacity
and resources, affecting its ability to manage and oversee large-scale hydropower projects efficiently. The lack of
a comprehensive strategy for engaging local communities further exacerbates conflicts and resistance to projects.
Moreover, insufficient transparency and accountability in decision-making processes have led to skepticism among
stakeholders, resulting in diminished trust in IBNs commitment to facilitating investment.

Geopolitical challenges have significantly constrained Nepal’s ability to expand electricity exports to India
and Bangladesh. India plays a critical role in shaping Nepal’s hydropower export landscape, currently receiving
around 900 MWs of electricity exports from Nepal. While India has expressed interest in increasing electricity im-
ports from Nepal, particularly to support its broader clean energy goals, it has been selective in granting market



64 I Nepal Country Economic Memorandum
access. India’s 2018 Cross-Border Electricity Trade guidelines limit electricity imports from projects financed by
third-country investors, allowing only those developed under bilateral agreements. This restriction complicates Ne-
pal’s efforts to attract foreign investment from countries like China, which have shown interest in Nepal’s hydro-
power sector. Furthermore, securing long-term PPAs with India has been difficult, as India ensures imports align with
is strategic and economic interests.

India’s regulatory framework and approval process further hinder Nepal’s ability to export electricity at a
scale. Although some progress has been made in recent years, the quantities of power allowed for export remain
limited. Additionally, India’s dominant position in South Asia’s electricity trade creates a dependency that leaves
Nepal vulnerable to political fluctuations. Tensions or disagreements between the two nations have previously stalled
energy agreements, delaying the development of more robust cross-border electricity markets. These dynamics
underscore the need for Nepal to diversify its energy partnerships and pursue approaches to mitigate the risks of
over-reliance on a single market.

Expanding electricity trade with Bangladesh offers a promising opportunity for Nepal to reduce its depend-
ence on India. Bangladesh has a growing demand for electricity and has shown strong interest in importing clean
energy from Nepal. However, since Nepal lacks a direct transmission link with Bangladesh, such trade must occur
through Indian territory, requiring India’s approval. This dependency adds another layer of complexity to Nepal’s
export strategy. To overcome these challenges, trilateral agreements involving Nepal, India, and Bangladesh could
facilitate smoother cross-border electricity trade. Initiatives such as the Bangladesh-Bhutan-India-Nepal (BBIN)
regional framework could be leveraged to promote greater energy cooperation, streamline regulatory processes, and
ensure mutual benefits for all parties involved.


Low domestic electricity demand has deterred faster growth of the sector
In addition to delays in export agreements, the slow growth in domestic electricity demand has been a bot-
tleneck for Nepal’s hydropower development. The profitability of larger-scale hydropower projects relies on con-
sistent, high-volume demand for electricity. Even though per capita electricity consumption has increased by an
average 10 percent annually over the past decade, it started from a very low base, and Nepal continues to lag
significantly behind regional peers (Figure 4.5). The stagnation of the manufacturing sector and limited household
demand have been key reasons for limited demand, contributing to the slow expansion of the hydropower sector.


Nepal’s households have relied on biomass for energy, rather than electricity
Nepal’s households continue to mostly consume energy created from biofuels and waste (Figure 4.6). Resi-
dential electricity consumption has steadily increased in Nepal, around threefold between 2010 – 2022, albeit from
a very low base. Overall, electricity remains small in the residential energy mix, having accounted for only around 5
percent in 2022. Biofuels and waste, despite stagnating since 2016, remain the main source of residential energy,
accounting for roughly 90 percent of the energy mix.

The rise in residential electricity consumption has been primarily driven by the growing reliance on electric-
ity for lighting. From 2011 to 2021, the share of households using electricity for lighting surged from 67.3 percent
to 92.2 percent. This growth was most notable in rural areas, where the share of households relying on electricity for
lighting jumped from 60.9 percent to 85 percent. Although urban areas also saw an increase, from 94.1 percent to
95.7 percent, the growth was less pronounced due to their already high electrification rates.

The use of electricity for cooking, on the other hand, remains negligible. In 2021, only 0.5 percent of households
used electricity for cooking, a modest rise from 0.1 percent in 2011. Both rural and urban areas experienced slight
increases, with rural households rising from 0.07 percent to 0.36 percent and urban households from 0.12 percent
to 0.55 percent. However, most Nepali households still rely heavily on traditional fuels such as wood or firewood (51
percent) and imported Liquefied Petroleum Gas (LPG, 44.3 percent) for their cooking needs.



                                                                      Nepal Country Economic Memorandum I 65
Figure 4.5. Per capita electricity consumption (Kwh)          Figure 4.6. Household energy consumption in TJ
in 2022	
         7000                                                         25000                                        400000
                                                                                                                   350000
         6000                                                         20000
                                                                                                                   300000
         5000                                                         15000                                        250000




                                                              In TJ
                                                                                                                   200000
         4000
In Kwh




                                                                      10000                                        150000
         3000                                                                                                      100000
                                                                      5000
                                                                                                                   50000
         2000
                                                                            0                                      0




                                                                                2017
                                                                                2018
                                                                                2016


                                                                                2019
                                                                                2020

                                                                                2022
                                                                                 2011

                                                                                2013

                                                                                2015
                                                                                2010



                                                                                2014
                                                                                2012




                                                                                2021
         1000

           0                                                                        Oil products     El ctricit
                 CHN LAO IND KHM LKA PAK BGD NPL                                    Biofu ls nd w st (rhs)

Source: International Energy Agency                           Source: International Energy Agency



Electricity demand from firms has been hampered by the weak manufacturing sector, but also
services consume limited electricity

The stagnation of the manufacturing sector restrained electricity demand from industrial firms. Manufactur-
ing output fell to around 6 percent of GDP in 2022, significantly lower than in regional and structural peer countries
(see Chapter 1). The lack of dynamic in the sector restricted domestic demand for electricity. In 2022, Nepal’s industry
sector consumed roughly 12,800 TJ of electricity (Figure 4.7), with a peak demand of only around 2,170 MW. While
electricity consumption more than doubled compared to a decade ago, it only accounted for 9 percent of final indus-
try energy consumption in 2022, substantially lower than in regional peers. Bangladesh’s industry sector, for example,
consumed around 147,000 TJ of electricity in 2022, which constituted 35 percent of the sector’s energy mix.

Figure 4.7. Industry energy consumption in TJ                 Figure 4.8. Services energy consumption in TJ
         70000                                                 25000
         60000
                                                               20000
         50000
         40000                                                  15000
In TJ




         30000                                                  10000
         20000
                                                                  5000
         10000
                0                                                       0
                 2010 2012 2014 2016 2018 2020 2022                         2010 2012 2014 2016 2018 2020 2022
                      Co l            Oil                                    Co l         Oil products        El ctricit
                      El ctricit      Biofu ls nd w st                       Biofu ls nd w st            Wind, sol r, tc.

Source: International Energy Agency                           Source: International Energy Agency


Electricity consumption of Nepalese services firms has been similarly low, despite the important role the
sector plays in the economy. Electricity consumption by services more than doubled over the past decade and
reached 4,100 TJ in 2022 (Figure 4.8). Despite the increase, electricity accounted for only 13 percent of final services
energy consumption in 2022. While the consumption of biofuels dropped during the past decade, they remain the
main source of energy for services, having accounted for 60 percent of the services energy mix in 2022.




66 I Nepal Country Economic Memorandum
Infrastructure challenges remain
One of the main reasons for the continuous unreliability of electricity supply is Nepal’s weak transmission
and distribution network. The existing infrastructure is often outdated and inadequately maintained, leading to
frequent power outages and inefficiencies in energy delivery. With a limited capacity to transport electricity from
hydropower plants to end-users, significant energy losses occur during transmission. In 2024, for example, NEA
announced system losses of 12.7 percent. This not only hampers the reliability of electricity supply but also deters
potential investments in the energy sector.

Nepal’s weak infrastructure associated with hydropower development poses significant challenges to har-
nessing its potential. Essential elements such as access roads, bridges, and transportation facilities are often lack-
ing or poorly developed, making it difficult to transport equipment and materials to remote hydropower sites. Under-
developed infrastructure delays project timelines, increases costs, and limits the ability to implement maintenance
and upgrades on existing facilities. Infrastructure gaps compound the already challenging topography of the country.

Weak infrastructure, especially the absence of high-capacity cross-border transmission lines, is also a major
obstacle to increased electricity exports. Transmission lines, such as the 400 kV Muzaffarpur-Dhalkebar line, have
limited capacity to transfer power to India, and many other lines operate at lower voltages like 132 kV, which are insuffi-
cient for large-scale energy exports. This restricts Nepal’s ability to fully utilize its grid for exporting electricity, with cur-
rent cross-border transmission capacity limited to 1,000 MW. The lack of a comprehensive network of 400 kV or higher
voltage lines hinders efficient cross-border electricity trade, as high-voltage transmission is essential for reducing losses
over long distances and ensuring reliable power flow. Hence, even if electricity generation capacity were increased, with
adequate transmission lines, additional surplus electricity during monsoon season could not be fully exported.

Nepal’s high exposure to natural disasters significantly affects hydropower development. Nepal is prone to
earthquakes, landslides, and flooding, all of which can cause substantial damage to existing infrastructure and
impede the construction of new projects. The 2015 earthquake, for example, severely impacted several hydropower
plants, leading to operational disruptions and costly repairs. Furthermore, the frequent occurrence of landslides
and seasonal flooding can affect the reliability of water flow needed for hydropower generation. For example, the
September 2024 floods and landslides resulted in damage to 11 operational hydropower projects with an installed
capacity exceeding 600 MW, as well as transmission lines, thereby affecting both production and exports. These
natural vulnerabilities not only increase the risks associated with hydropower investments but also require additional
resources for disaster preparedness and risk mitigation.

Finally, most of Nepal’s hydropower plants are run-of-river, making them vulnerable to fluctuations in river
flow and sedimentation. Run-of-river hydropower plants account for more than 90 percent of the country’s total
hydropower capacity. The consequence is a strong seasonality in electricity production, which drops substantially
during the dry season due to the lack of water in hydropower plants. Several reservoir type hydropower projects have
been developed, such as the 1200 MW Budhi Gandaki or the 635 MW Dudhakoshi, but construction has stalled due
to the lack of financing.


4.3.	Avenues for economic growth through hydropower
Nepal’s hydropower sector has the potential to transform the structure of the economy and shape long-term
economic development. Hydropower can enable higher long-term economic growth through productivity increases
across industries, reducing costs and enabling firms to scale up operations by supplying stable and clean energy.
The availability of clean electricity can also attract both domestic and foreign investment, particularly in energy-in-
tensive industries like manufacturing, services, and green technologies. Additionally, with the right infrastructure in
place, surplus electricity can be exported to neighboring countries, such as India and Bangladesh, generating for-
eign exchange and enhancing Nepal’s role in the regional energy market. These exports could create a new revenue
stream for the government, fund infrastructure improvements, and reduce the country’s reliance on foreign aid.



                                                                              Nepal Country Economic Memorandum I 67
However, the path to fully developing Nepal’s hydropower potential is neither quick nor straightforward, and
without significant employment benefits. Large-scale hydropower projects are complex endeavors that take
years to plan, finance, and construct, often facing delays due to infrastructure bottlenecks, regulatory hurdles, and
environmental considerations. When operational, hydropower plants are not particularly labor-intensive, meaning
that most job opportunities are temporary and limited to the construction phase. As a result, while hydropower can
enable stronger overall economic growth and improve energy security, it is unlikely to be a major contributor to long-
term job creation compared to industries like tourism or manufacturing. Patience, strategic planning, and careful
management are essential to ensure that hydropower delivers sustainable benefits over time.

Yet, failure to expand its hydropower potential could undermine the country’s economic growth prospects.
Nepal’s firms already incur significant losses due to unreliable electricity supply, limiting their competitiveness and
ability to expand. Without addressing this energy bottleneck, the economy would continue to struggle with ineffi-
ciencies, missed opportunities, and higher production costs, deterring investment and further stunting industrial
growth. While the benefits of hydropower, whether domestic or through exports, are substantial, they can only be
fully realized through a strategic, long-term commitment to expanding and upgrading Nepal’s energy infrastructure.


Hydropower could enable stronger growth by boosting productivity, currently lagging that of peer
countries
The availability of green electricity from hydropower would significantly enhance firm productivity in Nepal.
Reliable, low-cost electricity reduces operational expenses by eliminating the need for expensive alternatives like
diesel generators, which are commonly used during power shortages. With a consistent energy supply, firms can
streamline their operations, avoid costly downtimes, and increase production efficiency. Firms would also be able to
invest more in energy-dependent technologies, such as automation and advanced machinery, which can boost out-
put and improve overall efficiency. By lowering energy costs and ensuring uninterrupted power, hydropower would
enable firms to allocate more resources toward growth and innovation, enhancing their competitiveness in both
domestic and international markets.

Green electricity from hydropower would also have a positive impact on lagging labor productivity by creat-
ing a more stable and efficient working environment. Workers would experience fewer disruptions due to power
outages, allowing them to maintain a steady workflow and meet production targets more consistently. Access to re-
liable electricity also supports the adoption of advanced tools and equipment that can enhance workers’ output per
hour. In sectors that require precision and high energy usage, such as manufacturing and information technology,
access to consistent energy can directly increase the value and volume of work produced by each worker. Finally,
labor productivity would also benefit from reduced pollution and improved air quality, which would lead to healthier
workers, fewer sick days, and higher performance levels.


Hydropower could boost growth by stimulating domestic production of goods and services
The industrial sector in Nepal could see growth and modernization with increased access to reliable and
cheap electricity from hydropower. Industries consume more energy than any other sector. The availability of
stable and affordable electricity would reduce their reliance on fossil fuels, which are exposed to global price volatility
and supply disruptions. This would lead to more efficient production lines, better quality control, higher production,
and the ability to meet higher demand. It could attract more domestic and foreign investors seeking to capitalize
on low energy costs and predictable energy supply. Finally, expanding energy-intensive sectors could also decrease
reliance on imports of energy-intensive products, like fabricated metals or electrical equipment, which currently
account for nearly 40 percent of merchandise imports.

The competitiveness of Nepal’s goods and services would also increase due to their green and sustainable
production. A shift to hydropower would allow Nepal to decouple growth from carbon emissions. This would enable
Nepal to brand its goods and services as green and sustainable, which could give the country a competitive edge



68 I Nepal Country Economic Memorandum
in global markets. Consumers in higher-income markets, including tourists, are increasingly striving to reduce their
carbon footprints. By powering industries, tourism, and services with clean, renewable energy, Nepal could appeal
to eco-conscious consumers and businesses that prioritize sustainability in their purchasing decisions. This green
branding would enhance the attractiveness of Nepalese products, particularly in sectors like manufacturing, agricul-
ture, and tourism, where environmental impact plays a significant role in shaping demand. As international demand
for sustainable goods and services grows, Nepal’s reputation as a green energy leader could boost exports and
investment, and thereby economic growth.

Particularly the tourism sector could benefit from the expansion of the hydropower sector and boost services
sector output. Reliable and clean energy would enable the development of modern amenities, such as upscale ho-
tels, restaurants, and recreational facilities, all of which are essential for attracting a higher volume of higher-income
tourists. Moreover, by branding itself as a green tourism destination, Nepal could appeal to the growing demographic
of eco-conscious travelers who prioritize sustainability in their travel choices. This shift would not only improve infra-
structure and services but also facilitate the promotion of environmentally friendly activities, such as eco-trekking,
wildlife conservation, and cultural tourism. As tourists increasingly seek out destinations with low environmental
impact, the integration of green hydropower could position Nepal as a leader in sustainable tourism.


Directly exporting hydropower to neighboring countries India and Bangladesh
Nepal could export significant amounts of hydropower even after meeting domestic demand. The govern-
ment’s target of installing 28,500 MW by 2035, with a projected domestic demand of 13,000 MW, aligns with this
export potential. India recently agreed to import 10,000 MW from Nepal in the next decade. Bangladesh agreed to
import 40 MW of electricity during the rainy season. However, key challenges exist. For example, existing arrange-
ments for cross-border electricity trade in South Asia and long-term power purchase agreements with India need
improvement. Additionally, India currently restricts Nepal from exporting electricity produced with foreign invest-
ment, excluding India.

Studies by the World Bank and Asian Development Bank (ADB) corroborate the positive economic impact of
hydropower exports. A World Bank study estimates that direct electricity exports could contribute US$ 3 billion
to Nepal’s GDP between 2024 and 2033, representing a 4.83 percent increase (WB 2022). ADB analysis suggests
that developing 20 percent of Nepal’s economically viable hydropower potential by 2030 could lead to an 87 percent
increase in GDP compared to a baseline scenario (ADB, 2020). Government revenue and royalties from electricity
generation would increase accordingly and allow for higher capital expenditure, which would provide an additional
stimulus to economic growth.

In theory, Nepal would have the potential to produce and export green hydrogen. The government of Nepal
has recently introduced a green hydrogen policy to promote hydrogen production in Nepal.36 Several studies (e.g.,
Bhandari and Subedi, 2023; Thapa et al. 2021) suggest that utilizing surplus hydropower for hydrogen production
could be cheap and highly profitable in Nepal. Bhandari and Subedi (2023) estimate that surplus hydropower can
produce 464,000 tons of hydrogen by 2028 at globally competitive prices, with a value of round €1.76 to €2.07 billion
in 2028.

However, several significant challenges would need to be addressed for Nepal to competitively produce and
export green hydrogen. Nepal would need to heavily invest in the infrastructure required to produce, store, and
transport hydrogen. The initial capital cost to start hydrogen production would hence be significant. For Nepal to
be competitive in such circumstances, facing stiff competition from China and India, would require a significant
scaling of production and careful consideration of niche markets and value-added products. Additionally, exporting
hydrogen would require efficient transport routes and an agreement with India. The latter appears challenging, given
Nepal’s experience on developing hydropower capacity for exports without Indian investments.




                                                                        Nepal Country Economic Memorandum I 69
4.4.	Looking ahead: How to boost hydroelectricity for economic
growth
Developing Nepal’s hydropower sector is a long-term game that requires clear policies and commitment. Pol-
icy ambiguities have undermined a more rapid and effective development of Nepal’s hydropower potential. While
governments have identified hydropower as a pillar of long-term economic development, more must be done. Gov-
ernments need to provide clear long-term policies and a comprehensive legal and institutional framework to fa-
cilitate increased private sector investment in hydropower. Paving the way for increased hydroelectricity exports
requires stronger engagements with India and Bangladesh.

Sufficient financing is a necessary precondition to achieve the development of the hydropower sector. Nepal
will need to stimulate domestic investment in hydropower and attract more foreign investors. Achieving this scal-
ing-up will require a strengthened IBN and increased capacity among public and private hydropower stakeholders.
Finally, increased domestic demand will be necessary to absorb additional hydropower generation capacity.

Table 4.1. Policy recommendations to boost hydropower development

                                               POLICY RECOMMENDATIONS

                   Recommendation                  Fiscal                  Recommendation                      Fiscal
                                                  Impact                                                      Impact

                                                  Creating Opportunities
         Strengthen the regulatory framework               Reduce bureaucratic hurdles for the private         
         and harmonize policies.                    Low     sector.                                            Low
Tier 1




         Strengthen the financing model for                Invest in transmission and distribution             
         hydropower projects.                       Low     infrastructure.                                    High
         Stimulate domestic electricity demand.      
Tier 2




                                                    Low

                                                  Creating Capabilities
         Enhance the capacity of key hydro-          
         power stakeholders.                        Low


 Recommendation 1: Strengthen the regulatory framework and harmonize policies.

Summary of the issue: The current structure of the market, the lack of a clear legal framework, and delays in the
implementation of the revised Electricity Act have significantly hindered hydropower development in Nepal. Without
a robust regulatory structure, the industry faces challenges such as delayed project approvals, legal ambiguities in
licensing, and difficulty securing private investment given the regulatory and bureaucratic challenges. Private invest-
ment in transmission and distribution has been barred.

How: Update the legal framework by enacting the pending Electricity Bill. Review existing energy legislation and pol-
icies with a view to harmonize them and facilitate private sector investment in electricity generation. Enable IPPs to
trade power, allowing them to directly transmit and distribute electricity to buyers. This would also facilitate higher
investment in the grid. Streamline the current project licensing process to prioritize project readiness and developer
capability, which would enhance efficiency, attract more investment, and ultimately accelerate the growth of Ne-
pal’s hydropower sector.

Example: India updated its legal framework to facilitate the development of renewable energy, including hydropower



70 I Nepal Country Economic Memorandum
and solar. The 2003 Electricity Act promoted competition, increased transparency, and facilitated private sector
investment. The 2015 National Tariff Policy provided additional stimulus to hydropower development.


 Recommendation 2: Reduce bureaucratic hurdles for the private sector.

Summary of the issue: Hydropower projects in Nepal require significantly more time from inception to completion
that in peer countries. One important factor for these delays are lengthy approval processes for private investment
in hydropower generation. Bureaucratic hurdles delay hydropower projects and private investors require multiple
approvals from several agencies.

How: Establish a one-stop-shop for all necessary approvals and clearances, effectively reducing the bureaucratic
burden for the private sector. Fast-track projects that meet specific criteria determined by IBN. Develop new cam-
paigns to promote Nepal’s hydropower sector to potential foreign and domestic investors. Centralize the permitting
and approval of infrastructure PPPs.

Example: Viet Nam created a National Investment Corporation (NIC) to attract and facilitate private investment in
infrastructure, including hydropower. NIC promoted private investments in hydropower, facilitated joint investments
between domestic and international investors, provided feasibility analysis, and assisted private investors on reg-
ulatory compliance. Georgia is a notable example of a country that reformed the regulatory framework to reduce
bureaucratic red tape.


 Recommendation 3: Strengthen the financing model for hydropower projects.

Summary of the issue: Developing the hydropower sector will require significant financing, up to US$ 46.5 billion
based on authorities’ estimates. To mobilize the required funds, Nepal will need to revamp its hydropower financing
model and attract additional private investments. Nepal’s capital market is currently not sufficiently developed to
provide the required funds, governments’ ability to raise financing through long-term bonds is limited. Foreign inves-
tors face bureaucratic and legal hurdles.

How: Develop a clear strategy with a time-stamped implementation plan for financing the development of the hy-
dropower sector, including: (i) the use of multilateral guarantees to maximize financing; (ii) a roadmap for developing
the domestic bond market to establish long-term benchmark bonds; (iii) a framework for implementing larger-scale
PPPs. Review the legal and institutional framework with a view to facilitate larger foreign currency investments by (i)
reducing bureaucratic red tape; (ii) increasing foreign currency investment limits; and (iii) providing effective currency
risk mitigation tools.

Example: Chile developed a clear financing framework to develop the renewable energy sector. The strategy in-
cluded a clear framework for PPPs, the issuance of green bonds, and the use of multilateral guarantees to enhance
infrastructure financing.


 Recommendation 4: Invest in transmission and distribution infrastructure, including cross-board lines.

Summary of the issue: Nepal’s weak electricity grid has been a roadblock to faster hydropower development and
reliable electricity supply. Domestic electricity supply remains unreliable due to insufficient transmission and distri-
bution infrastructure. Limited quality of cross-border transmission lines stands in the way of scaling up electricity
exports to Bangladesh and India.

How: Allocate more resources to strengthening the electricity grid, leveraging grants and concessional loans from
multilateral creditors, and aim at attracting FDI. NEA should build more capacity and dedicate resources to de-
veloping smart grid technologies with a view to reduce system losses and improve the efficiency of the grid. Open
transmission and distribution for private investors.



                                                                         Nepal Country Economic Memorandum I 71
Example: Bangladesh made substantial investments to improve its electricity infrastructure in the 2000s, imple-
mented a series of energy sector reforms, and attracted FDI. Rwanda’s Energy Sector Strategic Plan may offer
useful guidance for Nepal such as Germany’s energy transition, which included investment in renewable energy
integration and smart grid technologies.


 Recommendation 5: Stimulate domestic electricity demand.

Summary of the issue: Nepal’s per capita consumption of electricity is the lowest in the region, despite Nepal’s
abundant hydropower potential. Households have not yet adopted electricity for cooking, firms continue to con-
sume substantially less electricity than in peer countries. The reliability of electricity supply has contributed to
Nepal’s low electricity consumption. The government has announced several initiatives to stimulate the demand for
electricity in the past. However, the implementation of these initiatives-such as promoting electric stoves in house-
holds and increasing the use of both private and public electric vehicles-has been relatively slow.

How: Implement the 2024 High Level Tax Committee’s recommendation on removing subsidies on Liquefied Pe-
troleum Gas and revise electricity tariffs for household consumption. Mandate that new residential and industrial
constructions utilize electricity for ventilation, heating, and air conditioning. Consider tax incentives for firms that
switch from diesel or fossil fuel-powered generators to electric alternatives. Provide incentives through tariffs, such
as lower rates during off-peak hours, for industrial firms.

Example: Brazil, India, and South Africa all implemented relevant policies to stimulate domestic demand. Brazil’s
“light for all” initiative focused on connecting households to the electricity grid, in addition the country provided tariff
incentives and tax breaks to industries that adopted renewable energies. India subsidized electric cooking appliances
for households and incentivized energy efficiency for firms. South Africa provides subsidies for the adoption of elec-
tric appliances and tax deductions for firms improving energy efficiency.


 Recommendation 6: Enhance capacity of key hydropower stakeholders.

Summary of the issue: Capacity building for key hydropower stakeholders in Nepal is a pressing issue due to the
technical, regulatory, and financial complexities involved in developing large-scale projects. Many stakeholders, in-
cluding government agencies and private sector, would benefit from enhanced capacity, evidenced by the significant
delays in Nepal’s hydropower projects. Strengthening technical and managerial capacities could streamline project
development, improve regulatory oversight, enhance investor confidence, and help Nepal maximize its vast hydro-
power potential.

How: Develop a capacity building roadmap for the public sector in collaboration with the World Bank and Asian
Development Bank, focusing amongst others on: (i) improving skills in structuring and managing large-scale PPPs;
(ii) managing the contingent liabilities arising from PPP-like structures; (iii) strengthening inter-agency coordination
and collaboration; and (iv) attracting foreign investment in the sector. Capacity building could also be offered to
domestic financial institutions on appraising hydropower projects.

Example: Bhutan’s experience in building hydropower capacity could serve as a valuable example to Nepal. Bhutan
collaborated with India, academic institutions, and multilateral development banks to strengthen financial manage-
ment, project management, international financing mechanisms, and PPP management.




72 I Nepal Country Economic Memorandum
CHAPTER 5.
The Digital Sector:
A Driver of Growth and Job Creation
Nepal’s digital sector remains small compared to regional peers but has shown strong potential for growth and
job creation. Between 2005 and 2023, exports of digitally delivered services grew at an impressive annual rate
of 12.3 percent, placing Nepal favorably most South Asian countries. The country’s Information and Communi-
cation Technology (ICT) sector also outperforms many regional peers, with a higher percentage of employment
in ICT services.

Harnessing the full economic and employment benefits of digital technologies depend on their widespread adop-
tion and intensive use by both firms and households. Despite some progress, significant gaps remain. For in-
stance, as of 2023, 48 percent of firms still lack a website, and only 9.6 percent of payments and 23.3 percent
of customer sales are conducted electronically. ICT capital remains low, accounting for just 1.1 percent of total
capital in 2019, while high internet costs and frequent outages particularly affect smaller firms in 2023. Internet
penetration among households is also limited, with adoption at just 37.8 percent and computer usage at only 15
percent in 2021. A pronounced digital divide exists across sectors, firm sizes, and households, influenced by fac-
tors such as income, location, education, and gender. transformative effects of digital technologies on economic
growth and job creation hinge on their widespread adoption and intensive use by both firms and households.

Several obstacles continue to impede progress. These include the high cost of digital technologies, a weak reg-
ulatory environment in the ICT sector, slow expansion of fixed broadband infrastructure to rural areas, low
digital skill levels, and slow adoption of digital IDs and digital signatures. These factors contribute to significant
coverage and usage gaps in Nepal’s digital landscape.

To unlock the full potential of the digital sector and meet the government’s ambitious goals for IT exports and
job creation over the next decade, Nepal must address both the coverage and usage gaps. The coverage gap
stems from the commercial challenges of serving remote populations without government support, while the
usage gap reflects barriers that limit the demand for and adoption of digital technologies. Overcoming these
challenges will require a comprehensive approach, including regulatory reforms, accelerated development of
digital public infrastructure, reformation of the Rural Telecommunication Development Fund (RTDF), expansion
of digital skills programs, increased affordability of digital devices, and support for the transition to advanced
networks and technologies.




                                                                      Nepal Country Economic Memorandum I 73
5.1.	 The current state of Nepal’s digital sector
The digital sector encompasses a broad range of goods and services but is treated in this chapter as equiv-
alent to the ICT sector. It includes Business Process Outsourcing and IT-enabled Services (BPO-ITES), such as call
centers and data entry (Figure 5.1), as well as digital platforms beyond the traditional ICT sector, including digital
financial services, e-commerce, education platforms, ridesharing, and homestay services. However, this chapter
adopts a narrower focus on ICT services and manufacturing, unless otherwise specified, due to limited data on BPO-
ITES and other digital platforms.

Figure 5.1. Key segments in the digital sector

                                    SECTOR       SEGMENT                             FIRM EXAMPLES



                                      ICT
                    Th ICT s ctor




                                                                                                                 IT S rvic s
Th di it l s ctor




                                                                     -
                                    BPO-ITES




Source. World Bank (2024a).




74 I Nepal Country Economic Memorandum
5.1.1.	Overview of the digital economy

Nepal has been successful in exporting ICT services but not ICT goods
Nepal’s private sector has increasingly invested in ICT, around NPR 7.1 billion between 2017 and 2023 across
109 industries.37,38 This capital was estimated to have created 6,746 jobs. The diverse range of industries involved,
from small-scale enterprises to large-scale corporations, reflects the multifaceted nature of the ICT sector in Nepal.
For classification purposes, small industries are defined as those with fixed capital less than NPR 150 million, ex-
cluding micro-enterprises and cottage industries. Medium industries have fixed capital between NPR 150 million and
NPR 500 million, while large industries possess fixed capital exceeding NPR 500 million.


    Box 5.1. Fiscal incentives provided by the government to boost private sector
    investment in the digital sector




Nepal’s ICT service sector remains small overall but has contributed to real GDP growth. National accounts
data reveal that the ICT services sector accounted for 1.7 percent of Nepal’s nominal GDP in 2022, though larger
than in most South Asian countries except India (World Bank, 2024a). While its relative size may be modest, the sec-
tor has contributed an average of 0.3 percentage points to real GDP growth annually from 2012 to 2024. The private
sector plays a dominant role, accounting for nearly 80 percent of the sector’s value added (FNCCI and IFC, 2023).

ICT services present a significant opportunity for Nepal to drive export-led growth. This sector, which includes
telecommunications, computer, and information services, has consistently contributed to the country’s export rev-
enues. Over the past six years, ICT service exports have made up an average of 10 percent of Nepal’s total service
exports, amounting to 0.3 percent of GDP. This positions Nepal competitively within South Asia, with only Pakistan
surpassing it in ICT service exports as a percentage of GDP.

Nepal has outperformed most of its South Asian peers in the export of digitally delivered services (Figure
5.2). This broader category includes all international trade transactions delivered remotely via computer networks,
primarily over the internet. Nepal’s digitally delivered service exports represent a significantly higher percentage of
GDP compared to most countries in the region. From 2005 to 2023, these exports achieved a compound annual
growth rate of 11.6 percent, outpacing the 5.8 percent growth rate of non-digital services exports. By the end of
2023, digitally delivered services accounted for over 50 percent of Nepal’s total services exports, underscoring their
critical role in driving the country’s export-led growth.




                                                                      Nepal Country Economic Memorandum I 75
Figure 5.2. Nepal is competitive in exporting digitally                                                        Figure 5.3. … and employment in ICT services, while
delivered services…                                                                                            still small, is higher than in many peers.

                              7   6.5                                                                                                        4.0




                                                                                                               Emplo m nt in ICT s rvic s/
                                                                                                                                                   3.6
Di it ll d liv r d s rvic s




                              6                                                                                                              3.5




                                                                                                                 tot l mplo m nt (%)
       xports/GDP (%)




                              5                                                                                                              3.0
                                                                                                                                             2.5
                              4
                                                                                                                                             2.0              1.6
                              3
                                                                                                                                             1.5
                              2          1.6     1.6
                                                            1.1        1.1                                                                   1.0                      0.5
                              1                                               0.6        0.5      0.4                                                                        0.2
                                                                                                                                             0.5                                    0.0          0.0      0.0        0.0
                              0                                                                                                              0.0




                                                                                                                                                                                    B n l d sh
                                                                                                                                                   P kist n
                                                                                                  B n l d sh




                                                                                                                                                                                                          M ldiv s
                                                                                                                                                                                                 Bhut n
                                                                                                                                                              N p l
                                                            P kist n




                                                                                         Bhut n
                                         N p l




                                                                              M ldiv s




                                                                                                                                                                                                                     Sri L nk
                                                                                                                                                                             Indi
                                                                                                                                                                      Chin
                                                 Sri L nk




                                                                       Chin
                                  Indi




Source: UNCTAD and World Bank Staff calculations.                                                              Source: World Bank (2024a).



Despite the success of ICT services, Nepal encounters significant challenges in producing and exporting ICT
goods. This mirrors the broader challenges facing the country’s export-oriented industries (see Chapters 1 and 3
for details). A key factor contributing to this issue is the low level of FDI in the sector.39 ICT goods manufacturing is
largely dominated by multinational corporations, which operate within complex global value chains that create sub-
stantial barriers for Nepalese firms (World Bank, 2024a). In contrast, leading ICT goods exporters like China and Viet
Nam have developed their manufacturing industries through substantial FDI, focusing on labor-intensive production
and assembly (World Bank, 2024a). As a result, Nepal’s ICT goods exports remain minimal, while imports of these
goods account for 4 percent of the country’s merchandise imports, averaging 1.2 percent of GDP from 2014 to 2024.
Notably, communication equipment, including mobile phones, constitutes over half of total ICT goods imports, with
computers and peripheral equipment making up more than a quarter of the imports.


Employment in ICT remains small, partly due to a significant skill gap
Nepal’s ICT sector labor force has increased steadily but remains small (Figure 5.3).40 Data from the National
Population and Housing Census (2011 and 2021) show that the economically active population in the ICT sector grew
at a compounded annual growth rate of 5.1 percent, from 31,849 people in 2011 to 52,145 in 2021. This growth rate
is notably higher than the overall labor force growth rate of 4.2 percent, indicating a growing attraction to the ICT
sector. However, the ICT labor force remains small, accounting for only 0.35 percent of the total labor force in 2021.
Nevertheless, Nepal’s ICT services employment rate has been higher than in most other South Asian countries.

A significant gender gap persists, despite an increase in the number of economically active women in the
sector. The compound annual growth rate of economically active women in the ICT sector was 7.2 percent between
2011 and 2021, surpassing the employment growth rates for men and women across all sectors. However, the share
of women active in the ICT sector remains lower than for men. While the ICT sector accounted for around 0.2 percent
of the female labor force in 2021, it accounted for 0.5 percent of the male labor force.

A critical bottleneck to Nepal’s digital aspirations and stronger employment in the ICT sector is the lack of
skills among workers. Few Nepalis with intermediate and higher education possess the necessary skills to become
ICT and Science, Technology, Engineering, and Mathematics (STEM) professionals. Only 0.16 percent and 2 percent
of the population have completed education (intermediate equivalent and above) in the ICT and STEM fields, respec-
tively. This shortage of skilled professionals, coupled with the outmigration of existing skilled workers, hinders the
sector’s growth and potential contribution to the economy.



76 I Nepal Country Economic Memorandum
Student enrollment in Computer and IT engineering programs under the Council for Technical Education and
Vocational Training (CTEVT) has also consistently remained below the allocated quota. Although enrollment
in CTEVT Diploma and Pre-Diploma Level Computer Engineering programs steadily increased from FY19 to FY22, it
declined in FY23, staying below capacity throughout. On the other hand, CTEVT Diploma Level IT programs experi-
enced significant growth, with enrollment increasing more than sixfold during the same period. However, even with
this notable growth, enrollment still reached only half of the allocated quota. This persistent gap is driven by several
factors, including limited domestic job opportunities, the perceived diminishing value of TVET education, and the
increasing appeal of foreign education and employment prospects. 41


5.1.2.	 Progress in digital infrastructure

Digital infrastructure is crucial for the growth of the ICT sector, enabling effective communication and con-
nectivity. It comprises both hard (physical) and soft (software and regulatory) components. Reliable internet ac-
cess, robust telecommunications networks, and secured data centers represent hard infrastructure, while support-
ive policies, regulatory frameworks, and devices constitute soft infrastructure. Together, these elements facilitate
seamless information exchange and the development of innovative digital services. Inadequate infrastructure leads
to slow connectivity and limited access to resources, stifling growth, and competitiveness. Furthermore, strong
digital infrastructure attracts foreign investment and fosters a vibrant ecosystem for both start-ups and estab-
lished companies, enhancing productivity and driving economic development within the ICT sector and the broader
economy.


Nepal faces a broadband internet coverage gap
Nepal’s landlocked geography prevents direct access to global submarine cables, which are critical for high-
speed and reliable global internet connectivity. These cables drive investments in backbone infrastructure, like
internet exchange points, data centers, and fiber optic lines. As a result, Nepal relies on India and China for interna-
tional bandwidth, leading to additional costs due to taxes, tariffs, and foreign currency fluctuations, and subjecting
the country to the telecommunications laws of its neighbors. In 2023, Nepali companies spent NPR 4.7 billion im-
porting bandwidth, highlighting the economic impact of this dependence.

Nepal faces a significant coverage gap for fixed broadband internet. Nearly half of the country’s population
lives more than 10 kilometers away from fiber-optic infrastructure.42 Fiber-optic backbones, essential for modern
high-speed connectivity, span only 4,932 km, limiting the capacity and speed of the country’s digital networks and
network coverage. While this figure is concerning, it is relatively better than neighboring countries like Bangladesh
(41 percent), Pakistan (43 percent), and Sri Lanka (27 percent).

The government aims to tackle the fixed broadband coverage gap through the RTDF. This fund aims to expand
fixed broadband internet coverage by adding 6,300 km of optical fiber cables to connect the mid-hill eastern high-
way with 77 district headquarters and to provide non-dedicated broadband services with a minimum speed of 20
Mbps in selected areas. However, the project’s implementation has encountered delays, partly due to legal disputes.

Nepal’s mobile network coverage on the other hand has expanded significantly (Figure 5.4). Since 2014, 3G
coverage has increased by 10 percentage points, reaching 90 percent of population in 2023. 4G coverage, which
was introduced in 2017 and has reached approximately 88 percent of the population by 2023. 5G technology, which
promises connection speeds of up to 1,000 megabits per second, has yet to become commercially available, cover-
ing currently only 5 percent of the population.




                                                                       Nepal Country Economic Memorandum I 77
Figure 5.4. Mobile broadband network coverage has expanded…

                   96 98                        98 99          99 99        96 95          100100
            100                 90                                                                       90 88
                                      85
                                                                                                                       80 76
            80
                                                          63
  P rc nt




            60                                                                                      51

            40

            20                             13
                           0                                            1           0                            0             0
             0
                  B n l d sh     Bhut n            Chin          Indi       Sri L nk       M ldiv s         N p l      P kist n
                    3G Popul tion Cov r                   4G Popul tion Cov r               5G Popul tion Cov r

Source: https://www.mobileconnectivityindex.com/assets/excelData/MCI_Data_2024.xlsx.


Figure 5.5. … but the network quality lags peers.

           100

            80

            60
 P rc nt




            40

            20

             0
                    2014       2015         2016      2017       2018       2019        2020         2021      2022      2023
                  B n l d sh      Bhut n           Indi        Sri L nk         M ldiv s       N p l        P kist n      Chin


Source: https://www.mobileconnectivityindex.com/assets/excelData/MCI_Data_2024.xlsx.



The quality of Nepal’s mobile broadband network has improved in recent years but still lags regional peers
(Figure 5.5). The expansion of 4G infrastructure and increased consumer adoption have been key drivers of this pro-
gress. Download speeds have nearly doubled, and upload speeds have seen a remarkable sixfold increase, partially
fueled by expanded spectrum allocation. Despite these advancements, Nepal’s network performance, as measured
by a mobile network index, remains below average in the region, primarily due to slower download and upload speeds
compared to other South Asian countries.


Nepal’s data infrastructure development surpasses that of many regional neighbors
Data infrastructure, including internet exchange points (IXPs), data centers, and cloud computing, is critical for
improving the affordability and quality of fixed broadband service. Nepal Internet Exchange (NIXP) was established
in 2002 and serves as the country’s sole IXP. With two locations in Lalitpur and Kathmandu, NIXP facilitates internet
traffic between major telecommunication companies, internet service providers, and government agencies. By enabling
data to be exchanged locally instead of routing it through international transit providers, NIXP helps reduce overall
data transit costs leading to more affordable internet services. While NIXP boasts a higher-than-average number of
members compared to other South Asian IXPs, its limited traffic per capita indicates lower internet usage (Figure 5.6).



78 I Nepal Country Economic Memorandum
Figure 5.6. Monthly traffic of internet exchange point (ISXP) and number of connected data center per million
people
  6                                                                       5.4
  5                       4.5
                                                         4.2
   4

  3
                                          2.1
   2
                                1.3
          1.0
   1                                                                                                  0.5
                0.0                             0.2            0.1              0.0     0.0 0.1             0.2     0.0 0.1
  0
        B n l d sh        Bhut n           Chin            Indi           M ldiv s      P kist n        N p l       Sri L nk
       IXP monthl p      k tr ffic p r c pit (kilob t s p r s cond p r c pit )          Numb r of d t c nt rs (p r million p opl )

Source: World Bank (2024a) and https://datacentercatalog.com/countries.


Nepal, together with India, is at the forefront of data infrastructure development in South Asia. Nepal has
achieved a high level of sophistication characterized by the presence of an IXP, a diverse array of IXP participants,
large content providers, colocation data centers, and cloud service providers. According to Srinivasan, Comini, and
Minges (2021), countries with a greater number of data centers typically benefit from lower latency and reduced
data prices. Bhutan is positioned at an intermediate stage, featuring IXPs and diverse participants but lacking colo-
cation data centers. Bangladesh and Pakistan are still in the early phases of development, with only IXPs established
to date.

Nepal’s colocation data center density is notably higher than the South Asian average. Colocation data centers
offer shared infrastructure, including power, cooling, bandwidth, and communications, along with robust security.
Thereby, they eliminate the need for individual companies to invest in and maintain their own data centers, reducing
costs and improving operational efficiency. They also play a crucial role in the adoption of cloud services by acting
as essential “on-ramps” for businesses. Six colocation data centers currently offer essential data storage and pro-
cessing capabilities for Nepal’s firms.43


Nepal is committed to developing a robust digital public infrastructure
Nepal’s digital public infrastructure (DPI) is still in its early stages (Box 5.2) but has the potential to trans-
form the country’s digital landscape. DPI aims to create a secure, interconnected network of systems to ensure
equal access to public and private services. It bridges physical infrastructure like broadband networks with appli-
cations such as e-commerce and social services (World Bank, 2024a). Key components include a digital identity
system, a payment system, and data exchange, providing community-wide benefits. As DPI develops, it is expected
to improve public services, enhance individual welfare, and drive commerce and innovation.




                                                                                 Nepal Country Economic Memorandum I 79
    Box 5.2. Challenges in building a robust digital public infrastructure




Nepal has made notable progress in building its DPI ecosystem. Initiatives such as the National ID program,
Nagarik Mobile App, and connectIPS platform show the country’s commitment to digital transformation. The Na-
garik App, launched in 2021, now has over 800,000 users, offering access to services from 30+ government bodies.
ConnectIPS, introduced in 2018, enables seamless payments and fund transfers for 3.8 million users. Its growing
transaction volume reflects the increasing adoption of digital services, highlighting Nepal’s progress toward a more
digital future.


5.1.3.	 Progress in digital adoption by firms44

Most formal firms in Nepal45 had high-speed fixed broadband internet in 2023, according to the World Bank
Enterprises Survey. Large firms, with over 100 employees led the way with 96.7 percent fixed broadband internet
usage, followed closely by medium-sized firms (20 to 99 employees) at 93.7 percent and small firms (5 to 19 em-
ployees) at 92.1 percent. Internet usage was also higher in the services sector compared to manufacturing.

Yet only around half of firms had an online presence in 2023, leaving much room for improvement (Figure 5.7).
This nevertheless represents a significant increase from 2013, driven primarily by higher website adoption among
small businesses (Figure 5.8). The retail sector has witnessed the most substantial growth, with a remarkable 47.2
percentage point increase in website usage over the decade (Figure 5.9). These trends highlight a growing awareness
among Nepali businesses of the importance of a strong online presence for customer engagement and sales.




80 I Nepal Country Economic Memorandum
Figure 5.7. Digital technologies adoption by firms in South Asia
          60                                                                                                    53.7
                                                                               46.6                                                                                 48.8
           50
           40

           30                      25.8                                                                                                                                                       27.1
                                                                                                                                   23.3                                            21.7
           20                                            12.6
                                                                                                                             9.6
             10                               3.2
                     0
                                       B n l d sh                                                 Indi                  N p l                                          P kist n

                                 P rc nt of firms h vin th ir own w b sit                                        Proportion of p                     m nts m d         l ctronic ll
                                 Proportion of s l s p id b custom rs l ctronic ll
Sources: World Bank Enterprises Survey and World Bank staff calculations.
Notes: The data for Nepal is for 2023, while the data for other countries is for 2022.


Figure 5.8. Small firms saw the largest increase in website usage between 2013 and 2023…
                            90                                                                                                                                                              80.4
   sh r of tot l, p rc nt




                            80
                                                                                                  66.9
                            70
                                                                                                                                                           59.6
                            60                                                                                                52.0
                                                                    47.8
                            50
                            40
                            30         20.9
                            20
                            10
   s




                             0
                                      Sm ll                        M dium                    L r                             Sm ll                      M dium                              L r
                                                                    2013                                                                     2023

Sources: World Bank Enterprises Survey and World Bank staff calculations.	


Figure 5.9. … and the retail sector experienced the largest usage increase between 2013 and 2023

                            70                                                                                     66.6
 sh r of tot l, p rc nt




                                                                                                                                                        55.7           57.1                    53.7
                            60                                                  49.0
                            50                                                                                                     43.0
                                    36.3
                            40
                                                                                                         26.1
                            30                      19.6
                            20                                        8.4
                            10
                             0
                                                                      R t il




                                                                                                                                                           R t il
                                                                                                         All




                                                                                                                                                                                                  All
                                     Hot ls




                                                                                                                    Hot ls
                                                                                 Oth r s rvic s




                                                                                                                                                                           Oth r s rvic s
 s




                                                    M nuf cturin




                                                                                                                                     M nuf cturin




                                                                     2013                                                                           2023
Sources: World Bank Enterprises Survey and World Bank staff calculations.




                                                                                                                    Nepal Country Economic Memorandum I 81
Figure 5.10. Digital payment usage varies widely                                                              Figure 5.11. … and sectors.
across firm sizes…
                                                                                                                                        50




                                                                                                               sh r of tot l, p rc nt
                          30                      27
 sh r of tot l, p rc nt



                                                                                                                                                   38
                                                                                                                                        40
                          25                 23               23                                                                                                     31
                                                                                                                                        30                                23
                          20                            17                                                                                                      22
                                                                                          14                                            20                                         15
                          15                                                        11          10                                                                                                  12 10
                                                                              9                                                                           9                                   9
                          10                                                                                                            10                                               5
                           5
                                                                                                                                        0




                                                                                                               s
                          0
 s




                                                                                                                                                   Proportion of s l s       Proportion of
                                     Proportion of s l s p id Proportion of p m nts                                                                p id b custom rs         p m nts m d
                                         b custom rs            m d l ctronic ll                                                                      l ctronic ll            l ctronic ll
                                          l ctronic ll                                                                                              Hotels          Manufacturing      All
                                                  Sm ll       M dium          L r         All                                                       Retail          Other services

Sources: World Bank Enterprises Survey and World Bank staff                                                   Sources: World Bank Enterprises Survey and World Bank staff
calculations.                                                                                                 calculations.


Figure 5.12. Tangible ICT capital per worker grew faster…
                                    14
        p r work r t FY19 pric s,




                                                                                                                                                   11.7
                                    12
                                                                                                                                             9.3                 9.6
              NPR thous nd




                                    10                        8.2                                                                                         8.7
                                    8                                7.0
                                                  6.1
                                    6                   4.7
                                                                                           3.9
                                    4                                                                2.4                                                                                2.5
                                                                                                                                                                                              1.5
                                    2                                                                                                                                      0.1 0.3
                                                                              0.0 0.1
                                    0
                                                    T n ibl ICT                    Int n ibl ICT                                               T n ibl ICT                     Int n ibl ICT
                                                                           FY11                                                                     FY19

                                                                             Sm ll              M dium                              L r                   All
Sources: Manufacturing Census 2011/12, Nepal National Industry Survey 2019/20, and World Bank staff calculations.


Figure 5.13. ... than that of intangible ICT capital per worker

                                    2000
   p r work r t FY19 pric s,




                                                   1752
         NPR thous nd




                                    1500
                                                                                                                                          1145 1146
                                                         857         827                                                                           904 1007
                                    1000
                                                               631
                                     500
                                                                                   13 9        11 11                                                                        0.1 1.4 3.7 2.5
                                         0
                                                   T n ibl non-ICT                Int n ibl non-ICT                                          T n ibl non-ICT              Int n ibl non-ICT
                                                                            FY11                                                                                     FY19
                                                                                  Sm ll              M dium                             L r                   All

Sources: Manufacturing Census 2011/12, Nepal National Industry Survey 2019/20, and World Bank staff calculations.




82 I Nepal Country Economic Memorandum
Nepal’s firms, especially in manufacturing, have not yet broadly adopted digital payments. In 2023, only 9.6
percent of firms made payments electronically (Figure 5.10). This rate is significantly lower than the regional average
and even below the percentage of sales paid electronically by customers (23.3 percent). Digital payment usage var-
ies widely across firm sizes and sectors (Figures 5.10 and 5.11). Larger firms had the highest share of payments made
digitally but may face higher transaction costs for receiving them, while medium-sized firms received a greater pro-
portion of their sales revenues through digital channels. Among sectors, manufacturing firms recorded the lowest
share of both payments made and sales revenues received digitally, whereas the hotel sector showed the highest
level of digital payment adoption.

The use of ICT capital per worker in Nepal’s manufacturing sector remains low, despite a modest increase
between 2011/12 and 2018/19. Tangible ICT capital, which includes computers and related machinery, rose from
NPR 7,049 in 2011/12 to NPR 9,562 in 2018/19 (at 2019 constant prices), reflecting a compound annual growth of
just 3.9 percent (Figure 5.12). However, the situation is bleaker when it comes to intangible ICT capital, such as soft-
ware, which saw a concerning annual decline of 5.8 percent per worker. While these growth rates are slightly better
than the 2.5 percent and -16.7 percent recorded for tangible and intangible non-ICT capital per worker, respectively
(Figure 5.13), the overall picture is grim. ICT capital still accounted for a mere 1.1 percent of total capital in both
2011/12 and 2018/19, highlighting a troubling stagnation in the adoption of crucial digital tools in the manufacturing
sector. This is lower than the over 5 percent for China (David, Harry, and Fukao, 2022) and the average of around 4
percent for the OECD, for which data are available.46

The COVID-19 pandemic, however, pushed more firms to invest in digital solutions47. Data from the Nepal Busi-
ness Pulse Survey reveals that firms across all sizes and sectors increasingly adopted digital technologies during the
pandemic. The share of firms investing in new equipment, software, or digital solutions jumped from 15.3 percent to
27.4 percent between June 2021 and May 2022. This increase was consistent across various sectors and firm sizes,
highlighting a widespread commitment to digital enhancement during the crisis.


5.1.4.	 Progress in digital adoption by households

The adoption of digital technologies by Nepal’s households increased, albeit from a low base and penetration
rates remain low, leading to a notable usage gap.48 Internet usage soared from a minimal 3.3 percent in 2011 to
a still modest 37.8 percent in 2021, reflecting a compounded annual growth rate of 30.1 percent. Alongside a pop-
ulation coverage of 48 percent (see section 5.1.3), this resulted in a usage gap of 10.2 percent. Ownership of mobile
phones and computers also grew, with compounded annual growth rates of 10.8 percent and 9.7 percent, respec-
tively. However, the overall adoption rate for computers remains insufficiently low at 15 percent.49

Despite the near universal coverage of mobile broadband, market penetration also remains low. As of the end
of 2023, 3G market penetration stood at 25 percent, while 4G penetration was at 69.3 percent.50 This created con-
siderable usage gaps of 65 percent for 3G and 18.7 percent for 4G.

The use of digital technologies among households varies significantly across Nepal’s seven provinces. Accord-
ing to the Nepal Living Standard Survey 2022/23, Bagmati leads both in internet and computer usage with rates
of 59.6 percent and 29.1 percent, respectively. In sharp contrast, Madhesh lags woefully in computer usage with a
share of 1.1 percent, Karnali trails significantly in internet penetration with just 14 percent of households.

Socioeconomic factors like wealth, residence, age, education, and gender are the key drivers of disparities
in the use of digital technology. Wealthier households demonstrate vastly higher rates of internet and computer
usage compared to their less affluent counterparts. 11.5 percent of urban households use computers and 49.3 the
internet, compared to 2.5 percent and 17.5 percent of rural households, respectively. Older households (age 50+)
show markedly lower rates of digital technologies usage. Educational attainment compounds these differences,




                                                                       Nepal Country Economic Memorandum I 83
with individuals having secondary education or higher being significantly more likely to use digital technologies than
those with only basic or no education. Gender disparities are also pronounced, with male-headed households report-
ing higher computer usage compared to female-headed ones.

The use of digital payment methods among households has increased, but less than in peers. Digital payments
offer a more cost-effective alternative to cash transactions and are crucial for expanding financial inclusion. The
share of adults making or receiving digital payments in Nepal climbed from 9.9 percent in 2014 to 28.6 percent in
2021.51 This is lower than in other lower-middle income countries (LMICs) and South Asian peers, where digital pay-
ment adoption rates were 38.3 percent and 33.7 percent on average. There are significant gender, age, education,
and income disparities.52

The COVID-19 pandemic accelerated the adoption of digital payments among adults.53 Global Findex data for
2021 indicates that nearly 1.5 million adults (5.1 percent of the population) began using digital payments post-pan-
demic, with urban areas experiencing a more significant increase compared to rural regions. Data from Nepal Rastra
Bank (NRB) corroborates this trend, showing a substantial increase in both the number and volume of digital trans-
actions between July 2020 and July 2022.


5.2.	The key impediments to digital adoption
Progress in digital technology adoption has been hindered by several significant challenges. Key factors include
the lack of affordability of digital technologies, a weak regulatory environment in the ICT sector, slow expansion of
fixed broadband infrastructure in rural areas, low digital skill levels among the population, and limited advancements
in the adoption of digital IDs and digital signatures. These issues have resulted in considerable coverage and usage
gaps, underscoring the urgent need for comprehensive reforms to harness the full potential of digital technologies.


Lack of affordability of digital technologies
Nepal’s fixed broadband prices remain relatively high while mobile broadband affordability has improved
significantly. The cost of mobile broadband has decreased substantially in relation to average Gross National In-
come (GNI) per capita, to 2.14 percent in 2023, just above the UN Broadband Commission’s affordability target of 2
percent GNI per capita (Figure 5.14). Fixed broadband, on the other hand, remains less affordable with a cost of 7.8
percent of average monthly GNI per capita (Figure 5.15).

Figure 5.14. Prices for data-only mobile-broadband basket (2GB) remain high as a share of monthly GNI per
capita…	

                                15
 sh r of monthl GNI p r c pit




                                10


                                5


                                 0
                                     2013    2014    2015    2016    2017     2018    2019   2020       2021      2022    2023
                                     B n l d sh     Bhut n    Chin     Indi      Sri L nk    M ldiv s          N p l     P kist n

Sources: https://www.itu.int/en/ITU-D/Statistics/Dashboards/Pages/IPB.aspx.




84 I Nepal Country Economic Memorandum
Figure 5.15. … as do prices for fixed broadband basket (5GB) as a share of monthly GNI per capita.	
 sh r of monthl GNI p r c pit   20

                                15

                                10

                                 5

                                0
                                     2013    2014     2015   2016   2017     2018    2019   2020        2021      2022     2023
                                     B n l d sh     Bhut n   Chin     Indi      Sri L nk     M ldiv s          N p l     P kist n

Source: https://www.itu.int/en/ITU-D/Statistics/Dashboards/Pages/IPB.aspx.



Higher fixed broadband prices in Nepal are partly due to heavy taxation. The ICT sector faces a 30 percent
corporate tax rate, on par with the rates for alcohol and tobacco, in addition to a 13 percent value added tax (VAT)
rate. Moreover, several sector-specific taxes exacerbate the financial burden, including: i) license and renewal fees;
ii) spectrum fees of 0.4 percent of revenues; iii) a 2 percent contribution to the Rural Telecommunication Develop-
ment Fund, levied on Internet Service Provider; iv) 4 percent royalty fees, levied on Internet Service Provider; v) a 13
percent telecommunication service charge; vi) a 100 percent internet fee as a support and maintenance charge; vi)
a Telephone Ownership Tax of NPR 500 for installing a telephone or 2 percent on every SIM card and recharge card
for prepaid phones; vii) a 10 percent tax deducted at service for international bandwidth entry into Nepal; viii) a 10
percent fee charged by network service providers for internet bandwidth; ix) a 15 percent customs duty on optical
fiber cable and drop cable; and x) a VAT on digital payment services. These cumulative costs are ultimately passed
on to consumers.

Device affordability has also continuously worsened. The affordability of entry-level smartphones has deterio-
rated in recent years, presenting a significant barrier to digital inclusion. The average cost of an internet-enabled
phone now amounts to 33 percent of monthly income in 2023, making it increasingly difficult for low-income indi-
viduals and households to access digital devices. A major factor contributing to the decline in affordability is the high
tax burden on phones, which reached 71.4 percent in 2023, far exceeding that of India (3.1 percent), Sri Lanka (29.9
percent), and Bangladesh (0 percent).

The average annual cost of internet services poses a significant burden to smaller firms. Average annual costs
amount to approximately NPR 31,500 or US$ 236. For small firms, internet expenses accounted for 0.7 percent of
overall input costs, while it was only 0.1 percent for large firms. This cost disparity is evident across sectors, with
hotels facing the highest internet expenses at 2 percent of input costs, in stark contrast to manufacturing firms,
which recorded the lowest level of 0.1 percent of input costs.

Frequent internet outages continue to disrupt business operations and hinder sales. Over 30 percent of firms
experienced significant internet disruptions during the 2022, with an average downtime of 3.5 hours (Figure 5.16).54
This unreliability had a substantial negative impact on businesses, resulting in a notable 2.1 percent annual sales
loss for the average firm.




                                                                                      Nepal Country Economic Memorandum I 85
Figure 5.16. Duration of internet disruption and the impact of disruption on sales were larger for small firms…	
   50
                                 42.9
   40        34.0      34.1                 34.2

   30

   20

    10                                                                                                   3.7                                3.5
                                                        2.3       1.3         1.1         2.1                      2.7          1.9
     0
                  Int rn t disruption                     Int rn t disruption s l s                     Int rn t disruption dur tion
                    (p rc nt of tot l)                        (p rc nt of tot l)                                  (in hour)

                                                     Sm ll      M dium          L r             All

Sources: World Bank Enterprises Survey and World Bank staff calculations.	


Figure 5.17. … and firms in “other services” sector.
    45
            37.6 36.2                38.3
    40                                       34.2
    35
    30                        25.4
    25
    20
    15
    10                                                 4.3                                              5.1                           5.1
                                                                                    3.3    2.1                            2.2                3.5
     5                                                         0.3      1.0                                      1.3
     0
                    Int rn t disruption                    Int rn t disruption s l s                      Int rn t disruption dur tion
                      (p rc nt of tot l)                       (p rc nt of tot l)                                   (in hour)

                                        Hot ls      M nuf cturin              R t il            Oth r s rvic s           All

Sources: World Bank Enterprises Survey and World Bank staff calculations.


The impact of internet outages varies across firm sizes and sectors. Larger firms are disproportionately af-
fected by internet outages, although their disruptions tend to be shorter and less damaging (Figure 5.16). Smaller
firms, while facing internet outages less frequently, experience both longer downtime and a more significant decline
in sales when disruptions occur. Among sectors, firms in the “other services” sector55 are most vulnerable to internet
outages, suffering from longer downtime and a greater impact on revenue compared to other sectors (Figure 5.17).


Weak regulation and high market concentration
Nepal’s Telecommunications Act from 1997 was designed for the pre-digital era and is outdated. The law was
established before the widespread adoption of data-based communications and the emergence of digital infra-
structure. NTA’s regulatory effectiveness is further hindered by its lack of independence. Its members are appointed
by the Ministry of Communication and Information Technology, which gives rise to potential conflicts of interest,
complicating the regulatory landscape.

Nepal’s ICT regulatory environment is therefore weaker than in other LMICs and has not improved over the
past 15 years. In 2022, the International Telecommunication Union’s (ITU) ICT Regulatory Tracker (ICT-RT) scored
Nepal’s overall regulatory framework at 60 out of 100, below the 66.1 average for LMICs. The lower score was
primarily due to weaknesses in the regulatory regime and competition framework and characterizes Nepal as a
Generation 2 early open market with basic reforms and partial liberalization and privatization.56 Alarmingly, Nepal’s



86 I Nepal Country Economic Memorandum
categorization has not improved but remained constant over the last 15 years, while the share of LMICs in Genera-
tions 1 and 2 has decreased from 94 percent in 2007 to 46 percent in 2022.

The weak competition framework score reflects a highly concentrated broadband market. Currently, mobile
broadband services are dominated by just two players. The state-owned operator Nepal Telecom controls 57.5
percent of the market while Ncell, a private company, controls the remaining 42.5 percent. The lack of competition
extends to the fixed broadband internet sector, where over 20 companies exist, but six major players capture nearly
80 percent of the market share. A high concentration can stifle innovation, lead to higher prices for consumers, limit
service expansion, and ultimately hinder the quality of the service offered.

Recognizing this challenge, the Nepal Telecommunication Authority (NTA) is taking steps to introduce a third
mobile operator. A Frequency Auction57 will allow new players to participate and potentially disrupt the current
market dynamics. The winner of the auction will receive a spectrum allocation and a license to operate as a mobile
broadband service provider, offering a full range of services approved by the NTA. Additionally, Nepal recently elimi-
nated the minimum threshold for FDI in the ICT sector, aiming to attract more foreign investment in its telecommu-
nication services. These initiatives have the potential to foster a more competitive landscape, ultimately benefiting
consumers through improved services and potentially lower prices.

The weak regulatory regime score reflects the lack of infrastructure sharing and secondary trading of spec-
trum, which authorities intend to address through a new regulation. According to ITU, infrastructure sharing
can lead to significant cost savings, up to 30 percent for passive infrastructure and 50-60 percent for active in-
frastructure. Nepal has already established the “Bylaws Related to Infrastructure Sharing and Fee Determination
of Infrastructure Sharing, 2021,” which outlines the active (e.g., base stations, routers, switches) and passive (e.g.,
towers, shelters, buildings, land) infrastructure eligible for sharing. However, a major issue with the regulation is the
reluctance of dominant players to share their infrastructure and the lack of effective enforcement mechanisms.

The new spectrum policy introduced by government in 2023 does not allow for spectrum trading. While the
policy recognizes emerging technologies like Internet of Things (IoT) and Machine-to-Machine (M2M) it falls short
of international best practices by not allowing spectrum trading, a crucial component especially for high-demand
spectrum typically associated with long license terms and high premiums (e.g., mobile spectrum). 58 This omission
is significant, with nearly one-third of economies globally permitting spectrum trading.59 Secondary spectrum trad-
ing enables companies to sell or lease unused spectrum, maximizing resource efficiency and value.60 It also grants
licensees with long-term licenses the flexibility to adjust their holdings in response to changing market demand and
technological advancements. Finally, a secondary market ensures more accurate spectrum valuation as prices ad-
just to reflect real market conditions.


Slow progress in expanding fixed broadband infrastructure in rural areas
The commercial viability of expanding internet coverage to rural areas is limited in Nepal. The rugged terrain,
remote locations, sparse populations, and low-income levels all contribute to high infrastructure costs and limited
market potential. Nepal’s low population density reduces the number of potential customers per kilometer of net-
work and further discourages investment. Finally, the economic constraints in rural areas make it difficult to offer
services at affordable rates, worsening the digital divide.

In 2012, the government established the RTDF as a universal service fund to support rural areas. The RTDF
aims at developing, expanding, and operating telecommunications in Nepal’s rural areas. It is designed as a self-sus-
taining system, with all licensed telecommunication service providers required to contribute 2 percent of their annual
revenue to the fund. The fund’s resources are allocated strategically through competitive bidding.

Currently, the RTDF is focused on two key initiatives. First, the construction of an optical fiber network aims at
connecting the mid-hill (eastern) highway with district headquarters. Progress, however, has been slow, with only



                                                                        Nepal Country Economic Memorandum I 87
1,694.1 km out of the targeted 4,669.2 km of optical fiber installed so far. The second initiative aims at providing
non-dedicated broadband services that can be shared among multiple users with a minimum speed of 20 Mbps in
selected areas. As of January 2024, only 165 out of 732 local levels have been connected, with 387 km of optical
fiber cable installed out of the targeted 1,634 km. The Broadband Access Connectivity project provided broadband
access to local government offices, ward offices, secondary schools, and health centers across 708 local levels.

Despite these efforts, data from the Center for Education and Human Resource Development (CEHRD) high-
light a concerning gap. By the end of 2024, 41.8 percent of the 27,990 community schools lacked computers, and
56.9 percent did not have broadband internet.


Low level of digital skills
A digitally skilled workforce is crucial for Nepal to unlock its technological potential, foster innovation, and
drive the country’s digitalization efforts forward. Wiley’s Digital Skill Gap Index assesses the availability of dig-
ital skills across countries and evaluates how prepared the workforce in various nations is to meet the demands of
an increasingly digital and tech-driven economy. The index measures digital skills across five key areas including
information and data literacy, communication and collaboration, digital content creation, safety in digital environ-
ments, and problem solving. Mastering these competencies is crucial for developing a digitally skilled workforce and
enhancing digitalization in Nepal.

Based on the 2021 digital skill gap assessment, Nepal has one of the largest digital skill gaps in South Asia
and globally. Out of 134 economies assessed in the index, Nepal ranks 124th, lower than other South Asian coun-
tries. Nepal performed particularly poorly in the areas of information and data literacy, communication and collabo-
ration, and digital content creation. With a score of just 2 out of 10, where 10 represents excellent digital skills, Nepal
ranks considerably lower than India, which scored a 5. This poor ranking highlights Nepal’s urgent need to develop a
more digitally skilled workforce to harness its technological potential and drive innovation.

Nepal’s adult population demonstrates a limited ability to perform even basic digital tasks. According to 2023
data from the United Nations Educational, Scientific, and Cultural Organization (UNESCO), only 9 percent of Nepal’s
adults (ages 15 and older) can execute fundamental tasks like copying and pasting text within documents. A mere
5 percent can use basic formulas in spreadsheets, and only 1 percent can write computer programs, well below the
averages of 3 percent for LMICs and 6 percent for high-income countries (HICs). 2023 data from the Ministry of
Education, Science and Technology reveals another concerning trend that less than 1 percent of students in grades
11 and 12 opt to major in computer science.

Digital literacy challenges are a key impediment to improving digital skills in Nepal. A household survey con-
ducted in Nepal in 2017/18 identified digital literacy as the main barrier to internet use among adults. Among non-us-
ers, 77 percent cited digital literacy as the main obstacle, with two-thirds unaware of what the internet was and 10
percent unsure of how to use it (LIRNEasia, 2018). Other obstacles included affordability concerns (9 percent), with
8.5 percent lacking access to a computer or smartphone and 0.5 percent finding costs prohibitive. Additionally, 12
percent noted relevance issues, while other factors accounted for 2 percent of the responses.


Delay in adoption of key digital public infrastructure elements
The adoption of digital identities (IDs) is still lagging, primarily because it has not been widely integrated
into use cases. Despite 15 million registrations so far, access restrictions to the digital ID platform have hindered
its widespread use. The focus on issuing physical ID cards has been a key obstacle to broader digital ID adoption.
However, the government’s recent decision to increase the use of digital IDs for various services from 2025 should
improve adoption rates. It will be critical to ensure that access to services remains unimpeded for those yet without
IDs during the transitional period.




88 I Nepal Country Economic Memorandum
Digital signatures were legally recognized in 2006 but remain underutilized in Nepal. Although the Electronic
Transaction Act 2006 and Electronic Transaction Rules 2007 provide for digital signatures, their use remains low.
Banking institutions continue to rely on physical signatures, highlighting the need for regulatory reforms to equate
digital signatures with physical ones. While there has been progress, such as the Office of Company Registrar adopt-
ing digital signatures in October 2023, it has taken nearly eight years since their official recognition in December 2015.

Security issues like server and data breaches have fueled a notable lack of trust in digital payment systems.
The lack of confidence data breaches caused in the past is further reflected in the rising use of paper-based pay-
ment instruments in Nepal between 2018 and 2022, as reported by the Alliance for Financial Inclusion (2024), which
stands in contrast to declining trends in other South Asian countries.


5.3.	How digital technologies can boost growth and jobs
Digital technologies can significantly enhance firm productivity, the key driver of sustained economic growth.
These technologies, including the internet, computers, or mobile phones, serve as powerful tools for efficiently gath-
ering, storing, analyzing, and transmitting data. They significantly reduce various economic costs (Goldfarb et al.,
2019), including search, replication, transportation, and verifications costs. By reducing these expenses, firms can
boost profitability, promote economic inclusion, enhance efficiency, and drive innovation, all of which contribute to
increased productivity and, ultimately, economic growth.

During the pandemic, digital technology adoption and investment were closely linked to an increase in digital
sales. An analysis of panel data from the Nepal Business Pulse Surveys, using a fixed-effects estimator, revealed
that firms investing in new equipment, software, or digital solutions during the pandemic experienced an over 8
percent increase in their share of digital sales compared to those that did not invest (Annex Table A1). Similarly, firms
that began using or intensified their use of the internet, online social media, specialized apps, or digital platforms
saw a more than 5 percent rise in digital sales within the past 30 days, relative to firms that did not invest in digital
solutions (Annex Table A1). These findings underscore that digital adoption is as vital as digital investment for fully
unlocking the economic growth potential of digital technologies.

Firms adopting digital technologies also demonstrated significantly higher labor productivity than non-adop-
ters. Digital technologies can boost labor productivity by automating routine and repetitive tasks and freeing up
workers to concentrate on more complex, strategic, and high-value activities. An analysis of cross-sectional data
from the World Bank Enterprises Survey 2023 using an Ordinary Least Squares (OLS) estimator (Annex Box 1) re-
vealed that website usage is associated with approximately 27 percent higher labor productivity on average among
manufacturing firms (Column 1, Annex Table A2a). Additionally, OLS analysis of cross-sectional data from the Nepal
National Industry Survey 2019/20 indicated that a 1 percent increase in ICT capital leads to a roughly 10 percent
increase in labor productivity, ceteris paribus (Column 1, Annex Table A2b). Further analysis accounting for both
tangible and intangible ICT capital showed a 10.4 percent increase in labor productivity linked to tangible ICT capital,
while intangible ICT capital had a -3.3 percent effect, though the latter was statistically insignificant (Column 2,
Annex Table A2b). These findings highlight the substantial impact of digital technology adoption on enhancing labor
productivity in Nepalis firms.

These findings are robust to the use of panel data of firms from World Bank Enterprises Surveys. The results,
derived from a fixed-effects estimator, indicate that firm-level characteristics that do not change over time do
not alter the outcomes observed in the cross-sectional data (Columns 3-4, Annex Table A2a). Additionally, using a
fixed-effects estimator on panel data from manufacturing sub-sectors61 suggests an even greater impact of ICT
capital on labor productivity than what was observed in cross-sectional data (10.8 percent for ICT capital). However,
the impact is smaller when both tangible and intangible ICT capital are included in the analysis (Columns 3 and 4,
Annex Table A2b). It is important to note that these results should not be interpreted as a causal effect on labor
productivity, given the potential for simultaneous determination between ICT capital and labor productivity.



                                                                        Nepal Country Economic Memorandum I 89
Digital technologies can also boost job creation in Nepal, both directly and indirectly. By reducing transaction
costs and fostering entrepreneurship and self-employment, these technologies open new avenues for employment.
Examples like Daraz Nepal, a foreign-owned e-commerce platform and a subsidiary of Alibaba Group, showcasing a
surge in registered sellers from 2,500 in 2019 to 20,000 62 within five years, illustrate this potential. Similarly, Food-
mandu, an online food delivery service, demonstrates the impact on job creation. Starting with a small team, they
now process an average of 2,000 orders daily and directly employ 450 people, including 300 delivery staff.63 The
low-wage structure, flexibility offered by remote work, and the availability of an English-speaking young population
make Nepal attractive for Business Process Outsourcing (BPO) companies. CloudFactory, a leading foreign-owned
BPO established in 2010, serves as a prime example. Their workforce grew from just three Nepali developers in 2010
to 325 full-time employees in 2019, with an additional 4,000 outsourced workers globally, primarily consisting of
college students in Nepal and Kenya.64


5.4.	Looking ahead: Policy recommendation to close the coverage
and usage gaps
Nepal has officially declared 2024 to 2034 as the Information Technology Decade, signaling a strong com-
mitment to digital transformation. The government previously demonstrated this dedication in the Digital Nepal
Framework (DNF) for 2019 – 2023, a comprehensive strategy that outlined 80 digital initiatives across eight sectors.
Nepal’s 16th Development Plan aims to increase the share of IT in nominal GDP to 5 percent and generate an addi-
tional 250,000 jobs by 2029.

However, significant efforts are still needed, as demonstrated by the sluggish implementation of the DNF.
Key initiatives such as digital signatures, 5G deployment, and establishing the internet as an essential service have
not advanced as anticipated. To adapt to the rapidly evolving digital landscape, the government is revising the DNF
to include emerging trends in artificial intelligence, digital public infrastructure, and cloud computing.

Nepal’s digital transformation efforts face several challenges, including a broadband internet coverage
and usage gaps. The coverage gap stems from the commercial unviability of serving remote populations without
government intervention. The usage gap highlights the demand-side barriers that hinder the adoption of digital
technologies. Nepal’s digital transformation, however, hinges on the widespread digital adoption by both firms and
households. Despite progress, only 52 percent of firms have websites and only a small portion uses electronic pay-
ments. ICT capital investment is low, the cost of internet high, and outages affect particularly smaller firms. Internet
adoption by households remains limited, with only 37.8 percent using the internet and 15 percent owning computers.
Digital divides persist across firm sectors, firm sizes, and household demographics.

Overcoming these challenges will require a multifaceted approach. Nepal needs to improve the regulatory en-
vironment, accelerate the development of digital public infrastructure, reform the RTDF, expand digital skills, make
digital devices more affordable, and promote the transition to advanced networks and technologies. By addressing
these gaps, Nepal can unlock the full potential of digital transformation for economic growth and job creation.




90 I Nepal Country Economic Memorandum
Table 5.1. Policy recommendations to boost digitalization

                              POLICY RECOMMENDATIONS – BOOSTING THE DIGITAL SECTOR

                  Recommendation                Fiscal                  Recommendation                        Fiscal
                                               Impact                                                        Impact

                                                 Creating Opportunities
         Improve the regulatory environment.            Accelerate the development of digital public           
                                                Low      infrastructure.                                       Low
Tier 1




         Reform the RTDF.                        
                                                Low
         Make digital technologies more                 Promote the transition to advanced networks            
Tier 2




         affordable.                            Low      and technologies.                                     High

                                                  Creating Capabilities
         Expand digital skills.                  
Tier 1




                                                Low


 Recommendation 1: Improve the regulatory environment.

Summary of the issue: The ICT regulatory environment in Nepal is relatively weak compared to neighboring coun-
tries and other LMICs. The result is a concentrated broadband market, the absence of infrastructure sharing and
secondary spectrum trading, an outdated Telecommunications Act, and a lack of regulatory independence.

How: Foster a more competitive landscape through the establishment of a dedicated competition authority and
strengthen the financial and structural independence and rule-making authority of Nepal Telecom Authority. Up-
date the 1997 Telecommunications Act and the digital strategy to reflect the evolving digital landscape, emphasizing
the transition from voice to data-centric services, as well as addressing cybersecurity, personal data protection, and
ethical AI. Enable the leasing and secondary trading of spectrum and amend existing bylaws related to infrastruc-
ture sharing to strengthen enforcement measures and encourage participation.

Example: Italy has a robust ICT regulatory environment with an overall score of 99 out of 100 on the ICT regulatory
tracker. The country features full competition in both mobile and fixed broadband markets, mandates infrastructure
sharing, enables secondary spectrum trading, and has a dedicated competition authority.


 Recommendation 2: Accelerate the development of digital public infrastructure.

Summary of the issue: Nepal’s progress in building a robust DPI has been hampered by the slow adoption of digital
identity and digital signatures, coupled with concerns about digital payment security.

How: Promote the use of digital IDs for various government services while ensuring inclusion. Integrate digital sig-
natures in existing processes, such as banking transactions. To build trust in digital payments, prioritize user pro-
tection and security by implementing robust measures for personal data and consumer protection, enforce existing
electronic transaction laws, and enhance cybersecurity infrastructure.

Example: India Stack, a pioneering digital public infrastructure initiative, has significantly transformed the nation’s
digital landscape.65 Its core components, including Aadhaar, Unified Payments Interface (UPI), eSign, DigiLocker,
eKYC, and the consent layer, have collectively empowered citizens and businesses. By providing secure digital iden-
tity, facilitating seamless payments, enabling electronic document management, and empowering data privacy,
India Stack has fostered innovation, improved efficiency, and promoted financial inclusion.



                                                                       Nepal Country Economic Memorandum I 91
 Recommendation 3: Reform the Rural Telecommunication Development Fund.


Summary of the issue: Progress in utilizing the RTDF has been slow, coupled with a lack of transparency in report-
ing its usage. While the Nepal Telecommunication Authority publishes annual and quarterly reports on project im-
plementation, these documents are often not user-friendly and lack detailed information about the specific projects
being funded.

How: Increase transparency of the fund by ensuring that all project documents, including agreements, are presented
in a more reader-friendly format. Shift the emphasis of the RTDF towards providing demand-responsive services
tailored to the actual needs of rural communities, thereby addressing the existing usage gap. This could involve
funding low-cost data plans with special “friends and family” rates and facilitating access to devices such as smart-
phones, tablets, or computers.

Example: India sets a strong example by publishing comprehensive details of all project documents funded by its
Universal Services Fund, including agreements, thereby ensuring transparency and accountability.66 Malaysia has
effectively utilized its Universal Services Fund to support underprivileged communities, financing over 1.6 million
netbooks for low-income students and households between 2010 and 2015 and providing more than 2.5 million
smart devices from 2014 to 2020 at prices below retail, along with free internet subscriptions for rural areas and
low-income groups.67


 Recommendation 4: Make digital technologies more affordable.

Summary of the issue: Nepal’s digital adoption is hindered by the high cost of fixed broadband internet and mobile
devices, which is partly due to heavy taxation.

How: Leverage the RTDF to subsidize device purchases, making technology more accessible for underserved com-
munities. Evaluate the trade-offs between short-term fiscal revenue from digital infrastructure and services and
their potential long-term impact on digital technology adoption. Encourage the use of refurbished computers and
tablets as affordable options for schools and institutions.

Example: Malaysia successfully subsidized over 2.5 million smart devices from 2014 to 2020 for rural areas and
low-income groups through its Universal Service Fund.68 Canada’s Computers for Schools Plus (CFS+) program has
refurbished and distributed nearly 2 million computers and other digital devices for over 30 years.69 The program
targets schools, libraries, not-for-profit organizations, Indigenous communities, and eligible low-income Canadians.


 Recommendation 5: Promote the transition to advanced networks and technologies.

Summary of the issue: The deployment of new technologies such as 5G networks, was a key initiative of the DNF.
5G mobile technologies offer much higher speeds, lower latency in data transmission, and enhanced capacity to
connect large numbers of users simultaneously with minimal interference (World Bank, 2024b). Nepal has begun
piloting 5G technology, which was originally planned for rollout in 2021 but was postponed due to geopolitical issues.

How: Address spectrum costs by reforming the spectrum policy. Nepal’s 2024 spectrum policy permits all op-
erators to deploy 5G using existing or auctioned frequencies, starting in 2025. However, operators must clear all
government dues before participating in auctions. The government must balance increased spectrum revenue with
potential impacts on coverage and pricing. Share public infrastructure. High investment costs exceeding NPR 50
billion, largely due to the expensive establishment of mobile sites, have hindered 5G deployment by mobile operators.
Government support in providing public infrastructure could significantly reduce these costs (World Bank, 2024b).

Example: According to the Global System for Mobile Communications Association, 5G adoption is rapidly ex-
panding, with 98 countries having 5G networks and over half exceeding 50 percent coverage by December 2023.



92 I Nepal Country Economic Memorandum
Examples include the Maldives (58 percent), India (30 percent), and China (90 percent). In 2018, India’s Department
of Telecommunications recommended creating uniform guidelines for state and local governments and improving
the clearance process through online applications and prompt responses to facilitate 5G deployment.


 Recommendation 6: Expand digital skills

Summary of the issue: Nepal ranks very low in digital skills, both in South Asia and globally. Over two-thirds of the
adult population report difficulties related to digital literacy that prevent them from using the internet.

How: Integrate digital skills into school curricula and implement tailored training programs for different age groups
and demographics. CTEVT to develop demand-oriented training programs in partnership with industry that are
focused on high-end IT skills to create an employable talent pool.

Example: Singapore serves as a strong example of a country that has effectively promoted digital skills develop-
ment. The National Digital Literacy Program, launched in March 2020, targets schools and Institutes of Higher
Learning, focusing on a comprehensive approach to digital skills through the “Find, Think, Apply, Create” frame-
work.70 This framework is broken down into nine digital competencies, which aim to deepen digital literacy among
students as part of the EdTech Masterplan 2030. Additionally, the Digital Skills for Life program is designed to equip
all Singaporeans with essential digital knowledge and skills, enabling them to perform daily online tasks, navigate
the digital landscape, and protect themselves against online risks.71 Another significant initiative, the Skills Frame-
work for ICT, promotes mastery of ICT skills and supports lifelong learning for individuals, employers, and training
providers.72




                                                                      Nepal Country Economic Memorandum I 93
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98 I Nepal Country Economic Memorandum
Annexes
Chapter 2
Table A1: Nepal migration cycle and governance.
                                                                            MIGRATION STAGE

        Activities                     Before migration                       During migration                        After migration
    Education/                Vocational and Skill Develop-  On-the-job training
    Training                  ment Training Centre (VSDTC), from employer for the
                              Council for Technical Educa-   first few months
                              tion and Vocational Training
                              (CTEVT), Foreign Employment
                              Board (FEB), Skill Development
                              and Training Section, Migrant
                              Resource Center (MRC)1
    Job search/               MoLESS for Govern-                          Personal network/re-
    recruitment/              ment-to-Government                          cruitment agencies
    matching                  programs, Employment
                              Information Centres (EICs)2,
                              Private recruitment agencies,
                              family and personal migrant
                              networks
    Destination                                                           FEB/Ministry of Foreign
    country/consular/                                                     Affairs -Embassy and
    remittances/other                                                     consulates/MoLESS-
    rights protection                                                     Labor Attaches and
    and welfare                                                           counsellors/Insurance
                                                                          companies
    Return and                                                                                              FEB, Employment
    reintegration                                                                                           Coordination and Information
                                                                                                            Section, Employment service
                                                                                                            centres (ESCs) are established
                                                                                                            under the Prime Minister
                                                                                                            Employment Program
                                                                                                            (PMEP) of MoLESS with
                                                                                                            management from local
                                                                                                            governments, MRCs

Source: MoLESS, Nepal Labor Migration Report (2022), pg 11-50.
Notes: Agencies in blue are units housed within the Ministry of Labor, Employment, and Social Security (MoLESS). Although under MoLESS, the
larger departments VSDTC and DoFE are housed outside the ministry. FEB is an autonomous body under MoLESS but governed through a Board
comprising several stakeholders.
MRCs have been established under the bilateral support of Switzerland with management from Helvetas Nepal under technical assistance. Its
1

objective is to provide support throughout the full cycle of migration including skills training, financial literacy, legal/paralegal, and psychosocial
support, but is not present only in 38 districts (out of 77) within the premises of the district administration offices (DAOs) (and one in the Depart-
ment of Passport in Kathmandu).




                                                                                         Nepal Country Economic Memorandum I 99
Chapter 3
Annex 3.1
Table A1: Key Regression Variables

                      VARIABLE                            MEAN         MIN    MAX
BRER (2011)                                                      1.4    0.0   271.9
BRER (2021)                                                      2.4    0.0   262.6
Input Tariff (2011)                                         0.010 0.000       0.084
Tariff on Nepal (2011)                                      0.022 0.000       3.030
Tariff on Nepal (2021)                                      0.014 0.000       5.136
Average Tariff in Destination Market (2011)                 0.043 0.000       3.027
Average Tariff in Destination Market (2021)                 0.052 0.000       5.130


Table A2: BRER and Exports, Baseline

                                 (1)          (2)          (3)

    VARIABLES              Exports        Exports        Exports
log(BRER)                 -0.294***                      -0.299**
                             (0.111)                      (0.136)
log(BRER), CPI                            -0.284**
                                           (0.122)
Observations                91,408          91,315        44,041
R-squared                    0.524          0.524         0.633
Fixed Effects              Baseline       Baseline       Extended
Standard errors are clustered at the destination level

*** p<0.01, ** p<0.05, * p<0.1




100 I Nepal Country Economic Memorandum
Table A3: BRER and Exports, Interactions

                                                   (1)                  (2)                (3)        (4)

             VARIABLES                          Exports               Exports        Exports        Exports
log(BRER)                                       -0.265**           -0.298***         -0.311***     -0.294***
                                                 (0.109)               (0.110)           (0.112)     (0.110)
log(BRER) x Larger                            -0.0707***                                           -0.0829***
                                                (0.0112)                                            (0.0113)
log(BRER) x Many Destinations                                         0.0115**                      0.0135**
                                                                   (0.00554)                       (0.00557)
log(BRER) x Many Products                                                           0.0354***      0.0471***
                                                                                    (0.00650)      (0.00759)
Observations                                    91,408                91,408             91,408     91,408
R-squared                                        0.525                 0.524             0.524       0.526
FE                                              Baseline              Baseline       Baseline       Baseline
Standard errors are clustered at the destination level
*** p<0.01, ** p<0.05, * p<0.1


Table A4: BRER and Exports, Extensions

                                        (1)                  (2)                   (3)

        VARIABLES                   Exports                Exports            Exports (WLS)
log(BRER), t-1 (default)            -0.292**             -0.295***               -0.423*
                                      (0.112)               (0.111)              (0.227)
log(BRER), t-2                                             0.00159
                                                         (0.00386)
log(BRER), t                                             0.00766*
                                                         (0.00393)
log(BRER) x India                  -0.935***
                                     (0.156)
Observations                         91,408                91,393                91,408
R-squared                             0.524                 0.524                 0.735
FE                                  Baseline               Baseline              Baseline
Standard errors are clustered at the destination level

*** p<0.01, ** p<0.05, * p<0.1




                                                                                     Nepal Country Economic Memorandum I 101
Table A5: Robustness Tests

                             (1)               (2)            (3)

    VARIABLES             Exports          Exports         Exports
log(BRER)                -0.259**         -0.393***       -0.289***
                           (0.105)         (0.0965)        (0.0998)
log(GDP)                    0.104                          0.362***
                           (0.218)                         (0.0887)
Input Tariff                               -2.917***      -3.000***
                                            (0.670)         (0.670)
Tariff on Nepal                           -0.790***        -0.778***
                                            (0.110)         (0.110)
Average Tariff                             0.861***        0.871***
                                            (0.125)         (0.125)
Observations              91,408            66,335          66,335
R-squared                  0.524             0.506          0.507
FE                        Baseline         Baseline        Baseline
Standard errors are clustered at the destination level

*** p<0.01, ** p<0.05, * p<0.1


Table A6: Input Tariffs and Exports, Baseline

                           (1)              (2)              (3)

    VARIABLES          Exports          Exports           Exports
Input Tariff           -2.080**        -3.283***         -4.251***
                        (1.024)           (1.128)          (1.377)
Observations            90,985           62,197            57,589
R-squared                0.521            0.679            0.720
FE                     Baseline        Extended I        Extended II
Standard errors are clustered at the product level
*** p<0.01, ** p<0.05, * p<0.1




102 I Nepal Country Economic Memorandum
Table A7: Input Tariffs and Exports, Interactions

                                                     (1)      (2)          (3)         (4)

              VARIABLES                         Exports    Exports       Exports    Exports
Input Tariff                                   -4.616***    -0.236        0.572     -1.942**
                                                 (1.147)    (0.695)      (0.581)     (0.970)
Input Tariff x Larger                          5.229***                             6.995***
                                                (0.983)                              (1.079)
Input Tariff x Many Destinations                           -2.462***                -2.791***
                                                            (0.710)                  (0.791)
Input Tariff x Many Products                                            -4.230***   -4.938***
                                                                         (0.631)     (0.726)
Observations                                    90,985      90,985       90,985      90,985
R-squared                                        0.523      0.520         0.521      0.524
FE                                              Baseline   Baseline     Baseline    Baseline
Standard errors are clustered at the product level
*** p<0.01, ** p<0.05, * p<0.1

Table A8: Input Tariffs and Exports, Extensions

                                                     (1)     (2)         (3)

              VARIABLES                         Exports    Exports     Exports
Input Tariff                                   -8.371***   -2.124**    -1.921*
                                                 (1.448)    (1.018)    (0.991)
Input Tariff x Size 25-50                      6.325***
                                                (0.879)
Input Tariff x Size 50-75                      8.648***
                                                 (1.348)
Input Tariff x Size 75-100                      10.12***
                                                 (1.766)
Import Competing Tariff                                    0.909**
                                                           (0.433)
Input Tariff x Lagged High Imp Sh                                      -4.754**
                                                                       (2.007)
Observations                                    90,985     90,985      90,985
R-squared                                        0.524      0.522       0.522
FE                                              Baseline   Baseline    Baseline
Standard errors are clustered at the product level
*** p<0.01, ** p<0.05, * p<0.1




                                                                        Nepal Country Economic Memorandum I 103
Table A9: Input Tariffs and Exports, Extensive Margin

                                    (1)                (2)            (3)           (4)

    VARIABLES                     # Prod             # Prod         # Dest        # Dest
Input Tariff                     -2.796**            -0.618        -2.785***       0.305
                                  (1.252)            (0.484)        (0.825)       (0.288)
Observations                      29,933             29,932         29,933        29,932
R-squared                         0.270               0.421          0.387         0.479
FE                         No Industry FE            Baseline    No Industry FE   Baseline
Standard errors are clustered at the product level

*** p<0.01, ** p<0.05, * p<0.1

Table A10: Partner Country Tariffs and Exports, Baseline

                                    (1)                 (2)            (3)

     VARIABLES                   Exports             Exports         Exports
Tariff on Nepal                  -0.835***           -0.851***       -0.744**
                                  (0.237)             (0.245)         (0.313)
Average Tariff                    0.813**            0.854**          0.532
                                  (0.330)             (0.336)        (0.327)
Observations                      68,413              68,308         64,810
R-squared                         0.503               0.508           0.543
FE                               Baseline        Extended I        Extended II
Standard errors are clustered at the product-destination level
*** p<0.01, ** p<0.05, * p<0.1




104 I Nepal Country Economic Memorandum
Table A11: Partner Country Tariffs and Exports, Interactions I

                                    (1)              (2)            (3)          (4)

     VARIABLES                   Exports          Exports        Exports       Exports
Tariff on Nepal                  -0.452**       -0.876***        -0.912***    -0.647***
                                  (0.179)         (0.226)         (0.241)      (0.182)
Nepal Tariff x Larger            -0.893***                                    -1.042***
                                  (0.308)                                      (0.291)
Average Tariff                   -0.00587        1.096***        1.080***      0.525*
                                  (0.278)         (0.373)         (0.357)      (0.306)
Average x Larger                 1.710***                                     2.060***
                                  (0.241)                                      (0.265)
Nepal Tariff x Many                                0.193                        0.460
Destinations
                                                  (0.283)                      (0.333)
Average x Many                                  -0.656***                     -1.006***
Destinations
                                                  (0.246)                      (0.243)
Nepal Tariff x Many                                               0.393*        0.480
Products
                                                                  (0.218)      (0.371)
Average x Many                                                   -0.948***    -0.985***
Products
                                                                  (0.292)      (0.319)
Observations                      68,413          68,413          68,413       68,413
R-squared                         0.504            0.503          0.503         0.504
FE                               Baseline        Baseline        Baseline      Baseline
Standard errors are clustered at the product-destination level

*** p<0.01, ** p<0.05, * p<0.1




                                                                             Nepal Country Economic Memorandum I 105
Table A12: Partner Country Tariffs and Exports, Interactions II

                                              (1)                 (2)       (3)

            VARIABLES                      Exports          Exports      Exports
Tariff on Nepal                            -0.424**         -1.411***    -1.442***
                                            (0.188)          (0.430)      (0.397)
Nepal Tariff x Pref. Margin                 -0.192
                                            (0.539)
Average Tariff                             -0.0640           -0.0128     -0.0125
                                           (0.398)           (0.453)      (0.407)
Average x Pref. Margin                     1.020**
                                            (0.493)
Nepal Tariff x Agriculture/Food                                  0.712
                                                             (0.471)
Average x Agriculture/Food                                   1.159**
                                                             (0.571)
Nepal Tariff x Homogeneous                                                0.563
                                                                          (0.431)
Average x Homogeneous                                                    1.713***
                                                                          (0.495)
Observations                                68,413           68,413       66,510
R-squared                                   0.503                0.504    0.504
FE                                         Baseline         Baseline     Baseline
Standard errors are clustered at the product-destination level
*** p<0.01, ** p<0.05, * p<0.1



Table A13: Partner Country Tariffs and Exports, Extensive Margin
                                   (1)          (2)

     VARIABLES               # Firms         # Firms
Tariff on Nepal            -0.269***        -0.239**
                                 (0.101)     (0.0933)
Average Tariff              0.439***         0.405**
                                 (0.152)      (0.158)
Observations                 18,995           18,885
R-squared                        0.508        0.524
FE                          Baseline        Extended
Standard errors are clustered at the product-destination
level

*** p<0.01, ** p<0.05, * p<0.1




106 I Nepal Country Economic Memorandum
Table A14: Im-Pesaran-Shin Panel Unit Root Test

                                        LEVEL         FIRST DIFFERENCE

       Variable             Statistic       p-value   Statistic    p-value
log REER                         2.1         0.981      -10.1      0.000
log GDP/capita                   5.2         1.000      -8.9       0.000
Terms of Trade                   0.1         0.542      -8.6       0.000
Aid/Capita                       -3.8       0.000       -12.9      0.000
Remit/Capita                     -0.7        0.241      -10.5      0.000

Table A15: Remittances and REER, Baseline

                                             (1)           (2)

          VARIABLES                       log REER       REER
log gdp per capita                         0.0982        7.472
                                          (0.0958)       (10.68)
log terms-of-trade                        0.0671*       8.118**
                                          (0.0358)      (3.996)
log financial aid per capita              0.0188**      1.967**
                                          (0.00813)     (0.907)
log remittances per capita                0.0145**      1.957**
                                          (0.00714)     (0.796)
Observations                                333           333
R-squared                                  0.312         0.323
Country FE                                  Yes           Yes
Year FE                                     Yes           Yes
Robust standard errors in parentheses

*** p<0.01, ** p<0.05, * p<0.1




                                                                           Nepal Country Economic Memorandum I 107
Table A16: Remittances and REER, Labor Force Participation

                                           (1)          (2)

           VARIABLES                    log REER     log REER
log gdp per capita                      0.00735      -0.00596
                                         (0.109)      (0.109)
log terms-of-trade                       0.0431       0.0415
                                        (0.0361)     (0.0362)
log financial aid per capita            0.0214***   0.0219***
                                        (0.00805)   (0.00807)
log remittances per capita              0.0232***    0.108***
                                        (0.00846)    (0.0406)
high lfp                                 0.0182
                                        (0.0136)
high lfp x log remit per capita         -0.0357**
                                         (0.0161)
Lfp                                                   0.0871
                                                      (0.116)
lfp x remit per capita                               -0.168**
                                                     (0.0706)
Observations                              332          332
R-squared                                 0.312        0.312
Country FE                                 Yes         Yes
Year FE                                    Yes         Yes
Robust standard errors in parentheses

*** p<0.01, ** p<0.05, * p<0.1




108 I Nepal Country Economic Memorandum
Table A17: Remittances and REER, Additional Interactions

                                          (1)         (2)         (3)           (4)

          VARIABLES                 log REER       log REER    log REER      log REER
log gdp per capita                      -0.0548    -0.0802     -0.0202       -0.00807
                                         (0.114)    (0.115)     (0.110)       (0.110)
log terms-of-trade                      0.0547      0.0517     0.0542         0.0476
                                        (0.0416)   (0.0413)    (0.0362)      (0.0364)
log financial aid per capita        0.0190**       0.0187**    0.0196**      0.0210**
                                    (0.00798)      (0.00795)   (0.00811)     (0.00813)
log remittances per capita              0.0227      0.0354     0.00534       -0.00861
                                        (0.0182)   (0.0307)    (0.0122)      (0.0183)
high import share                   0.0237**
                                        (0.0111)
high imp share x log remit              -0.0337
per capita
                                        (0.0207)
imp share                                          0.141***
                                                   (0.0478)
imp share x log remit per                          -0.0760
capita
                                                   (0.0562)
high serv share                                                 0.0130
                                                               (0.0115)
high serv share x remit per                                     0.0109
capita
                                                               (0.0151)
service share                                                                -0.0695
                                                                              (0.124)
serv share x log remit per                                                    0.0458
capita
                                                                             (0.0366)
Observations                              294        294         332           332
R-squared                                0.379      0.387       0.302         0.301
Country FE                                Yes        Yes         Yes           Yes
Year FE                                   Yes        Yes         Yes           Yes
Robust standard errors in parentheses

*** p<0.01, ** p<0.05, * p<0.1




                                                                        Nepal Country Economic Memorandum I 109
Annex 3.2: Exchange Rate Misalignment
The panel data model estimated in Section 3.3 can be used to estimate exchange rate misalignment.73 The
path of the REER is estimated using the model and compared to the actual path of the REER for 2001-2021.74 This
comparison is shown in Figure A1. The results imply that Nepal’s real exchange rate has in general been overvalued.
The peak overvaluation is about 11 percent in 2017, with the overvaluation down to 7 percent in 2020 and 4 percent
in 2021. The magnitude of the estimated overvaluation here is relatively modest compared to IMF (2020, 2023),
which report values in the 18 – 20 percent range, though IMF (2020) does suggest that their calculated gap may be
an overestimate.

Figure A1: REER vs. Equilibrium Estimated REER in Nepal
 130
 125
 120
  115
 110
 105
 100
   95
  90
   85
          2001

                 2002

                        2003

                               2004

                                      2005

                                             2006

                                                    2007

                                                           2008

                                                                  2009

                                                                          2010

                                                                                 2011

                                                                                         2012

                                                                                                2013

                                                                                                       2014

                                                                                                              2015

                                                                                                                     2016

                                                                                                                            2017

                                                                                                                                   2018

                                                                                                                                          2019

                                                                                                                                                 2020

                                                                                                                                                        2021
                                                                   REER                 Eqm. REER



Chapter 5
Table A1: Impact of adoption of digital technologies and investment in digital solutions on digital sales.

  DEPENDENT VARIABLE: DIGITAL SALES
 Adoption of digital technologies adoption                         5.031** (1.910)
 Investment in digital solutions                                  8.036*** (2.940)
 Firm FE                                                                   Yes
 Year FE                                                                   Yes
 Sector FE                                                                 Yes
 Number of observations                                                   822
 Adj. R-squared                                                          0.4105

Notes: Table A1 examines the impact of digital technologies and investment in digital solutions on digital sales. The dependent variable is the
share of firm’s last 30 days sales (in percent) that were based on external digital platforms, apps, or establishment’s website. The main explan-
atory variables include adoption of digital technologies and investment in digital solutions. Adoption of digital technologies is a binary variable
that takes a value of 1 if a firm has started using or increased the use of internet, online social media, specialized apps, or digital platforms in
the last 12 months, and zero otherwise. Investment in digital solutions is a binary variable that takes a value of 1 if a firm invested in any new
equipment, software, or digital solution in the last 12 months, and zero otherwise. Robust standard errors clustered at the municipality level are in
parentheses. Regression includes firm fixed effects and survey years fixed effects. *** and ** indicate significance at the 1 and 5 percent level. The
data includes 274 firms from Nepal Business Pulse Surveys that were surveyed in all three waves (May 2020, May-June 2021, and June 2022).




110 I Nepal Country Economic Memorandum
Box A1: Impact of ICT on labor productivity




Table A2a: Impact of website and digital payment adoptions on labor productivity (Equation 2)

                      DEPENDENT VARIABLE: LOG OF LABOR PRODUCTIVITY
                                    (1)               (2)              (3)                (4)
                               Manufacturing        Services      Manufacturing         Services




                                                            Nepal Country Economic Memorandum I 111
   Table A2b: Impact of ICT capital on labor productivity (Equation 2)

                          DEPENDENT VARIABLE: LOG OF LABOR PRODUCTIVITY

                                       (1)                  (2)          (3)   (4)




112 I Nepal Country Economic Memorandum
Endnotes
1	   Nepal’s data are on a fiscal year basis, e.g., 1996 refers to          are other reasons cited for the sluggish take-up rates (Shrestha
     FY1996.                                                                S. , 2023).
2	 During the post-conflict period, governments lasted on average       21	 This is also true for other periods. For example, between 1995
   only one year.                                                           and 2004, Lokshin et al. (2010) found that one-fifth of the pov-
3	 Sri Lanka’s pre-pandemic and pre-crisis average growth was               erty reduction was due to increased work-related migration and
   higher than Nepal’s.                                                     remittances. When accounting for local spillovers, Shrestha M.
                                                                            (2017a) found that migration to the Gulf and Malaysia explained
4	 GNI per capita is based on the Atlas method.
                                                                            40 percent of the overall poverty reduction in Nepal between
5	 Eckstein, D., V. Künzel, and L. Schäfer. 2021. Global Climate Risk       2001 and 2011 and more significant poverty reduction in villages
   Index 2021: Who Suffers Most from Extreme Weather Events?                with higher emigration during the period.
   Weather-Related Loss Events in 2019 and 2000–2019. Berlin:
                                                                        22	 A new edition of the Nepal Labor Force survey is being initiated
   Germanwatch.
                                                                            as of April 2024.
6	 Nepal Labor Migration Report 2022.
                                                                        23	 Methodologically, this broadly follows a prominent literature
7	   Sapkota, S., Shrestha, M., and Shrestha, S. “Returnees: A primer       studying the effects of trade policies and exchange rates on
     on a data and research agenda for Nepal”. Unpublished mimeo:           export-related outcomes using firm-level data. For example, see
     World Bank Staff estimates NLSS IV.                                    Chaterjee et al. (2013), Amiti et al. (2014) or Li et al. (2015) on
8	 World Bank Staff estimates NLSS IV; Nepal Labor Force Survey             the firm-level effects of exchange rates. On the effect of input
   2017.                                                                    tariffs, see for example Amiti and Konings (2007), Topalova and
                                                                            Khandelwal (2011), and Bas (2012).
9	 World Bank. 2021. “Risks to Poverty, Vulnerability, and Inequality
   from COVID-19: Nepal Light Poverty Assessment, World Bank,           24	 The estimated effects here are broadly in line with existing firm-
   Washington, DC.”                                                         level estimates from developing countries. Li et al. (2015) report
                                                                            a value elasticity of 0.25-0.41 for Chinese firms and Chaterjee et
10	 https://www.worldbank.org/en/country/nepal/brief/key-high-
                                                                            al. (2013) find a volume elasticity of 0.24.
    lights-country-climate-and-development-report-for-nepal
                                                                        25	 The regressions in Annex Tables A2 –A5 examine the effect
11	 The conflict period in this subsection covers 2002 to 2006 due
                                                                            of (log) bilateral RERs on (log) USD exports at the firm-prod-
    to the absence of expenditure data at constant prices.
                                                                            uct-destination-year level The bilateral RER is lagged one year
12	 Kyrgyz Republic and Lao PDR are excluded in the peer analysis           throughout to avoid mechanical simultaneity, and standard
    due to data limitations.                                                errors are clustered at the destination level. By default, all the
13	 Real exports data for Nepal is only available from 2001 onwards.        regressions include firm, product, destination, and year fixed
14	 Exports are classified according to their production technology.        effects (i.e., dummy variables) to control for potential omitted
    The classification is based on the importance of research and           variables. These are referred to as the “baseline” set of fixed ef-
    development expenditure relative to the gross output and value          fects. The “extended” set of fixed effects for the RER regressions
    added of the specific industry.                                         include firm-product-year interaction fixed effects and destina-
                                                                            tion fixed effects.
15	 Employment data includes non-wage jobs. Data are consistent
    with the 13th International Conference of Labor Statisticians       26	 The approach in all regressions focus on controlling for potential
    (ICLS) and includes work for subsistence reasons. For Nepal,            confounding factors primarily by using fixed effects. An addi-
    employment data comes from Ruppert Bulmer, Shrestha, and                tional potential control would be destination GDP (Annex Table
    Marshalian (2020), who converted employment data from 2018              A5, column 1). The results are robust to the inclusion of destina-
    Nepal Labor Force Survey to include subsistence employment.             tion GDP.25 The remaining columns of table 6 will be used and
    Employment between survey years is interpolated. For all other          explained at the end of section 2.5.
    countries, employment data comes from Penn World Tables             27	 Columns 1 - 3 of Annex Table A6 include different fixed effects,
    10.01.                                                                  however, all find a statistically significant impact of tariffs on
16	 Nepal’s services employment ratio grew faster than all South            exports, higher when using the more extensive set of controls.
    Asian countries expect for Bangladesh and Bhutan, and its in-       28	 The countries included are Afghanistan, Bhutan, Cambodia,
    dustry employment ratio grew faster than all except Bangladesh.         India, Lao PDR, Mongolia, Nepal, Pakistan, Papua New Guinea,
17	 A World Bank report from 2021 estimates that missing exports            Philippines, Solomon Islands, Sri Lanka, Vanuatu, and Viet Nam.
    amount to US$ 9.2 billion, around 12 times the annual mer-          29	 Nepal data is in fiscal years, e.g., 2022 refers to FY2022.
    chandise exports at that time. Most missing exports stem from       30	 https://www.iea.org/countries/nepal/energy-mix.
    potential trade with countries in the region that have currently
                                                                        31	 Timilsina and Steinbuks (2021) estimates that Nepal’s annual
    low trade links with Nepal.
                                                                            nominal GDP would have been 7 percent higher during 2008 –
18	 Nepal is one of the few countries remaining at a low risk of ex-        2016, had there been no load shedding.
    ternal and overall debt distress, as assessed by the low-income
                                                                        32	 Data on the reliability of electricity supply and its effect on firms’
    country debt sustainability framework (LIC DSF).
                                                                            operations stems from the 2013 and 2023 World Bank Enter-
19	 All migrants seeking foreign employment, except in India, require       prise Surveys.
    an employment permit from the Department of Foreign Employ-
                                                                        33	 Data are represented on a fiscal year basis.
    ment (DOFE), and the information is collected in the FEIMS.
                                                                        34	 Public investment was derived from stock numbers on plants
20	 Nepal Rastra Bank has issued FESBs since 2009; however, the
                                                                            and equipment, reported in NEA audited reports.
    program remains consistently undersubscribed. Low confidence
    in the government, less liquid bonds, and currency depreciation



                                                                                  Nepal Country Economic Memorandum I 113
35	 Private investment was derived from the World Bank Private            54	 2023 World Bank Enterprise Survey
    Participation in Infrastructure (PPI) database.                       55	 Other services primarily encompass transportation, motor vehi-
36	 The policy is available in local language at https://www.moewri.          cle services, publishing activities, as well as legal and accounting
    gov.np/storage/listies/January2024/green-hydrogen-pol-                    service.
    icy-2080.pdf.                                                         56	 Countries are classified into four generations based on the ma-
37	 Based on the documents submitted by investors during the                  turity of their ICT regulation. Generation 1 includes countries with
    registration of their industries and approved by the Department           scores below 40, characterized by regulated public monopolies
    of Industry. The data regarding industrial capital and the number         and a command-and-control approach. Generation 2 consists of
    of employees presented here are proposed or estimates.                    countries scoring between 40 and 69.6, representing early open
38	 Nepal data is in fiscal years, e.g., 2022 refers to FY2022.               markets that have implemented basic reforms, such as partial
                                                                              liberalization and privatization. Generation 3 encompasses
39	 As of the end of 2023, ICT services accounted for 6.7 percent of
                                                                              countries with scores between 70 and 84.9, which focus on
    the total FDI stock (see Nepal Rastra Bank, 2022/23).
                                                                              enabling investment, fostering innovation, and enhancing access,
40	 The economically active population (labor force) is defined as in-        while simultaneously promoting competition in service and
    dividuals aged 10 and above who have participated in economic             content delivery, and consumer protection. Finally, Generation 4
    activities within the sector in the past 12 months. The census            includes countries scoring between 85 and 100, known for their
    data does not disaggregate between employed and unemployed                integrated telecom regulation that aligns with broader economic
    individuals; therefore, we used the economically active popula-           and social policy goals.
    tion as a labor market indicator.
                                                                          57	 https://www.nta.gov.np/uploads/contents/White%20Paper%20
41	 https://ctevt.org.np/public/uploads/kcfinder/files/Situation%20           on%20Current%20Usage%20and%20Future%20Planning%20
    of%20Students%20Attraction%20towards%20Engineering%20                     of%20Radio%20Spectrum%20in%20Nepal.pdf
    Programs%20A%20Case%20Study.pdf
                                                                          58	 https://digitalregulation.org/spectrum-pricing-and-trading/
42	 https://bbmaps.itu.int/bbmaps/
                                                                          59	 https://datahub.itu.int/data/?i=100058
43	 These include Data Hub (Kathmandu and Butwal), Cloud Hima-
                                                                          60	 https://digitalregulation.org/spectrum-pricing-and-trading/
    laya, Dataspace, AccessWorld, and Government Integrated Data
    Center.                                                               61	 This data is derived from the Nepal Standard Industrial Classi-
                                                                              fication for four-digit manufacturing industries, as reported in
44	 This section is based on Nepal Business Pulse Surveys (2020,
                                                                              the Manufacturing Census of 2011/12 and the Nepal National
    2021, and 2022), World Bank Enterprises Surveys (2013 and
                                                                              Industrial Survey of 2019/20.
    2023), the Nepal National Industrial Survey (2019/20), and the
    Manufacturing Census (2011/12),                                       62	 https://kathmandupost.com/videos/2024/08/14/
                                                                              nepali-e-commerce-idea-of-nepal-with-aanchal-kunwar
45	 According to the National Economic Census 2018, there are a
    total of 923,356 firms in Nepal, of which 462,605 are formally        63	 https://ekantipur.com/en/feature/2024/07/14/fudmandu-has-
    registered, while the remaining are unregistered. The World Bank          been-cooking-national-and-international-dishes-for-a-decade-
    Enterprise Survey 2023 focused on all formal private sector               and-a-half-51-02.html
    businesses, defined as those with at least 1 percent private          64	 https://restofworld.org/2023/cloudfactory-nepal-layoffs/
    ownership and a minimum of five employees, totaling 49,102            65	 https://indiastack.org/
    firms. This represents 10.6 percent of all firms in the formal sec-
                                                                          66	 https://usof.gov.in/en/project-documents
    tor. Consequently, the nearly universal internet usage reported
    among these firms in this study may not be indicative of the          67	 https://www.krinstitute.org/assets/contentMS/img/template/
    entire formal sector and certainly does not reflect the situation         editor/230330%20USP%20Fund%20v2.0.pdf
    in the informal sector.                                               68	 https://www.krinstitute.org/assets/contentMS/img/template/
46	 https://euklems-intanprod-llee.luiss.it/download/. Data are not           editor/230330%20USP%20Fund%20v2.0.pdf
    available for South Asian countries. However, data from the           69	 https://ised-isde.canada.ca/site/computers-for-schools-plus/en
    Asian Productivity Organization show that the contribution of
                                                                          70	 https://www.moe.gov.sg/education-in-sg/educa-
    ICT to economic growth is low.
                                                                              tional-technology-journey/edtech-masterplan/
47	 Digital investment refers to whether firms have invested in any           digital-literacy-and-technological-skills
    new equipment, software, or digital solutions.
                                                                          71	 https://www.digitalforlife.gov.sg/About/Our-Projects/
48	 This is based on National Population and Housing Census data              Be-digitally-ready-with-Digital-Skills-for-Life
    conducted in 2011 (June 17-22, 2011) and 2021 (November 11-25,
                                                                          72	 https://www.imda.gov.sg/how-we-
    2021).
                                                                              can-help/techskills-accelerator-tesa/
49	 This stood at 73 percent for smart mobile phone.                          skills-framework-for-infocomm-technology-sfw-for-ict
50	 https://nta.gov.np/uploads/contents/MIS%20Report_2081%20              73	 This is a panel data implementation of the behavioral real ex-
    Ashadh.pdf                                                                change rate (Clark and MacDonald, 1999).
51	 World Bank Global Findex Database                                     74	 A level regression is used to obtain the initial (i.e. 2001) value.
52	 Central Bank Baseline Survey of Financial Literacy.                   75	 The data on this variable is available only for 2023 Enterprises
53	 Digital payments refer to whether individuals aged 15+ paid dig-          Survey.
    itally for an in-store purchase for the first time after COVID-19     76	 Capital stock data is not available for firms in services sector in
    or paid online for an online purchase for the first time after            Enterprises Survey.
    COVID-19.




114 I Nepal Country Economic Memorandum