Nepal Development Update Leveraging Resilience and Implementing Reforms for Boosting Economic Growth April 2025 © [2025] International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy, completeness, or currency of the data included in this work and does not assume responsibility for any errors, omissions, or discrepancies in the information, or liability with respect to the use of or failure to use the information, methods, processes, or conclusions set forth. 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Photos: Narendra Shrestha/World Bank Cover Concept and Design by Print Communications NEPAL DEVELOPMENT UPDATE April 2025 NEPAL DEVELOPMENT UPDATE ACKNOWLEDGEMENTS The Nepal Development Update is produced twice a year to report on key economic developments that occurred during the year, placing them in a longer-term and global perspective. The Update is intended for a wide audience including policymakers, business leaders, the community of analysts and professionals engaged in the economic debate, and the general public. This report was produced by the World Bank Economic Policy team for Nepal, led by Nayan Krishna Joshi (Country Economist), and consisting of Abdoul Ganiou Mijiyawa (Senior Country Economist) and Prabin Dongol (Consultant). Inputs were received from Alvin Etang Ndip (Senior Economist), Sabin Raj Shrestha (Senior Financial Specialist), and Sebastian Michael Essl (Senior Economist). The report benefitted from data and consultations with Hikmat B. Bhandari (Undersecretary, Ministry of Finance), Krishna Prasad Sharma (Senior Economist, Ministry of Finance), Dr. Birendra Bahadur Budha (Acting Director, Nepal Rastra Bank), and Suresh Neupane (Deputy Manager, CDS and Clearing Limited). The team thanks Mathew Verghis (Regional Director, Prosperity Practice Group), David N. Sislen (Country Division Director for Maldives, Nepal and Sri Lanka), Shabih Ali Mohib (Practice Manager, ESAC1), Ximena Del Carpio (Practice manager, ESAPV), Preeti Arora (Manager, Operations for Maldives, Nepal and Sri Lanka), and Arvind Nair (Senior Economist and Acting Program Leader for Maldives, Nepal and Sri Lanka, Prosperity Practice Group) for their guidance and comments on the report. Akash Babu Shrestha (External Affairs Officer) and Avinashi Paudel (External Affairs Associate) managed media relations and dissemination. Anima Maharjan (Program Assistant) and Shyam Sundar Sapkota (Team Assistant) managed the publication process. Sandhya Nepal (Graduate Intern) provided the support in data collection for the report. The cutoff date is March 26, 2025, and includes data released up until that date. The Nepali fiscal year generally begins on July 16 and ends on July 15 of the following year. 2 CONTENTS ACKNOWLEDGEMENTS 2 EXECUTIVE SUMMARY 6 A RECENT ECONOMIC DEVELOPMENTS A.1 Real Sector 10 10 A.2 External Sector 13 A.3 Monetary and Financial Sector 16 A.4 Fiscal Sector 20 B OUTLOOK, RISKS, AND CHALLENGES B.1 Real Sector 26 26 B.2 External Sector 27 B.3 Fiscal Sector 28 B.4 Risks and Challenges 29 THE WORLD BANK | 3 NEPAL DEVELOPMENT UPDATE 4 NEPAL DEVELOPMENT UPDATE | APRIL 2025 EXECUTIVE SUMMARY THE WORLD BANK | 5 EXECUTIVE SUMMARY RECENT ECONOMIC bank reduced the policy rate and the upper bound of the interest rate corridor by 50 basis points each. This followed DEVELOPMENTS a series of cuts in FY24, totaling 1.5 percentage points. These reductions, combined with subdued credit demand, led to a significant accumulation of excess liquidity, pushing lending Nepal’s economic growth accelerated in the first half rates to record lows. However, private sector credit declined, of FY25 (H1FY25). Real GDP grew by 4.9 percent in H1FY25, largely driven by reduced loans in the deprived sector and up from 4.3 percent in H1FY24, primarily due to a pickup in working capital loans. agricultural and industrial sectors growth, though a slowdown in the services sector partially offset this increase. The financial sector faced increasing challenges related to asset quality, profitability, and capital adequacy. The non- This acceleration occurred despite natural disasters performing loans (NPL) ratio surged to a record 4.9 percent by and disruptions in tourism. Floods and landslides caused the end of H1FY25, prompting a rise in loan-loss provisions damage equivalent to 0.8 percent of GDP, severely impacting that eroded sector profitability. In response, the central bank infrastructure, agriculture, and social services. Furthermore, introduced additional forbearance measures, including the ongoing upgrade of Tribhuvan International Airport, reducing the countercyclical buffer for FY25 to zero percent initiated in November 2024, led to major disruptions in the from the previous 0.5 percent. tourism sector, with reduced operating hours and increased ticket prices due to the absence of an alternative international On the fiscal front, the deficit narrowed significantly by airport. 0.5 percentage points of GDP in H1FY25, reaching near balance, driven by stronger revenue growth outpacing Headline inflation eased to 5 percent in H1FY25, down from slower expenditure increases. The revenue growth was 6.5 percent in H1FY24, aligning with the NRB’s inflation broad-based, with key contributions from higher import- ceiling. This decline was mainly driven by reduced non-food based and domestic excise duties, increased personal income and services inflation, particularly in housing, utilities, and tax revenue driven by higher capital gains, and rising non-tax restaurant services. However, food and beverage inflation revenue, particularly from higher dividends from financial and remained elevated at 7.5 percent, with vegetable prices rising service institutions. by 26.6 percent, despite the FY25 budget’s removal of VAT on select produce. On the expenditure side, a slight decrease was recorded, attributed to lower interest payments on domestic The current account surplus (CAS) moderated from 2.8 debt, reduced fiscal transfers to provincial and local percent of GDP in H1FY24 to 2.4 percent in H1FY25, as governments, and lower spending on goods and services. declining remittance inflows offset a lower trade deficit. However, capital expenditure remained steady, continuing to Remittance inflows fell from 12.9 percent of GDP in H1FY24 to be lower than debt servicing expenditure, a trend observed 12.4 percent in H1FY25, influenced by a 26 percent reduction since H1FY22. in migrant outflows, especially a sharp 74 percent drop in Nepali workers migrating to Malaysia. Meanwhile, the trade deficit narrowed as imports of goods and services reached their lowest level since H1FY16, driven by reduced imports of OUTLOOK, RISKS, AND petroleum products and outbound travel. On the export side, merchandise exports grew, particularly in refined edible oils, CHALLENGES and services exports saw a slight decline due to reductions in travel and transport services. Despite the narrowing CAS, Nepal’s economy is projected to grow by 4.5 percent in Nepal’s foreign exchange reserves remain adequate. FY25, up from 3.9 percent in FY24, and is expected to average 5.4 percent annually in FY26-FY27. The services The monetary policy stance remained cautiously sector is expected to be a primary driver of growth, bolstered accommodative in H1FY25. On July 26, 2024, the central by a recovery in merchandise imports that will stimulate 6 NEPAL DEVELOPMENT UPDATE | APRIL 2025 wholesale and retail trade in FY25. However, disruptions in FY25, as the growth in exports of goods and services, as a caused by the ongoing upgrade of Tribhuvan International share of GDP, outpaces that of imports, before widening in Airport—leading to reduced operating hours—are anticipated the medium term. Despite these dynamics, foreign exchange to hamper the government’s tourism targets and limit growth reserves are expected to remain at prudent levels, covering in the accommodation and food services sub-sectors for FY25. approximately ten months of imports by the end of FY27. Over the medium term, though, the airport improvements are expected to provide a positive contribution to the sector. The fiscal deficit is expected to stay at 2.5 percent of GDP in FY25, the same as in FY24, as lower revenues (including The industrial sector is forecast to grow robustly in the grants) are expected to be offset by reduced expenditures. medium term, largely driven by significant expansions in The deficit is projected to rise slightly to 2.9 percent of GDP by the electricity and construction sectors. Government efforts FY27, driven by higher interest payments and capital spending. to boost electricity capacity and increase energy exports are Revenue growth will hinge on the successful implementation set to further accelerate industrial growth. of the Domestic Revenue Mobilization Strategy. The deficit will be financed through external concessional loans and Additionally, supportive policies for the construction domestic borrowing, with public debt projected to rise to 43.4 sector, including extended loan repayment periods and percent of GDP by FY27—remaining within sustainable limits prioritized payments to contractors, are expected to drive as defined by fiscal regulations. activity starting in FY26. Meanwhile, the agricultural sector is projected to grow by 3.2 percent in FY25, supported by higher The risks to Nepal’s economic growth outlook are paddy production due to a favorable monsoon. Assuming primarily tilted to the downside. External risks, such as continued favorable weather patterns, agricultural growth is geopolitical uncertainties and rising trade restrictions, could expected to rise to 3.3 percent by FY27. push commodity prices higher. Nepal’s growth model is heavily reliant on remittances and tourism, so a slowdown Inflation in Nepal is expected to ease, moderating to 5 in partner countries’ growth could result in a decline in both percent in FY25 and averaging 4.4 percent over FY26-27. remittances and tourism, further hindering economic growth. This decline will be driven by lower non-food and beverage Domestically, further deterioration in financial sector asset inflation, reduced production cost pressures, and a positive quality could tighten private sector credit, while frequent agricultural output resulting from favorable monsoons in bureaucratic reshuffles could undermine policy consistency. FY26-27. Additionally, lower inflation in India—due to Nepal’s Additionally, Nepal’s continued presence on the FATF Grey List currency peg—will further stabilize prices in Nepal. presents a substantial risk to the economy. Another significant domestic risk is the prolonged delay in implementing critical capital expenditure reforms, which could hinder infrastructure The current account surplus is projected to narrow over the development, reduce economic efficiency, and limit long- medium term, primarily driven by lower remittance and term growth potential. On the positive side, the economy may a widening trade deficit. A slowdown in remittance growth benefit from the private sector-led growth reforms introduced is expected in FY25, reflecting the delayed impact of reduced through five ordinances passed by Parliament in March 2025. migration in FY24. Nepal’s trade deficit is anticipated to narrow THE WORLD BANK | 7 NEPAL DEVELOPMENT UPDATE 8 NEPAL DEVELOPMENT UPDATE | APRIL 2025 A RECENT ECONOMIC DEVELOPMENTS THE WORLD BANK | 9 A RECENT ECONOMIC DEVELOPMENTS REAL SECTOR A.1 Nepal’s economic growth accelerated in the first half of FY25 Growth in H1FY25 has been impacted by significant (H1FY25) amid natural disasters and tourism disruptions natural disasters and tourism disruptions. Natural disasters, including floods and landslides, caused damages Real GDP growth accelerated to 4.9 percent year-over- estimated at 0.8 percent of GDP, and disrupted key sectors year1 in H1FY25, up from 4.3 percent in H1FY24, driven such as infrastructure, agriculture, and social services (Box 1). primarily by a pickup in the agricultural and industrial Additionally, the ongoing upgrade of Tribhuvan International sectors growth (Figure 1). However, this increase was Airport, which began on November 8, 2024, has led to major partially offset by a slowdown in the services sector. travel and tourism related disruptions, including reduced operating hours and inflated ticket prices, due to the lack of an alternative international airport (Box 2). Figure 1. Real GDP growth accelerated in H1FY25 compared to H1FY24. (contribution to GDP growth, percentage points) Agriculture Industry Services GDP at basic prices 6 4 2 0 -2 1 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 Source. National Statistics Office (NSO) and World Bank staff calculations. 1 (contribution to services GDP growth, percentage points) Unless otherwise indicated, growth analysis is conducted on a half-yearly basis throughout the text. Wholesale and retail trade Transportation and storage 10 Accomodation Real estate activities Others Financial and insurance activities Services GDP NEPAL DEVELOPMENT UPDATE | APRIL 2025 Box 1. September 2024 floods The September 2024 floods in Nepal, occurring from September 26-28, were a devastating consequence of unusually intense monsoon rains, exacerbated by climate-related changes. Record-breaking rainfall in the Kathmandu Valley and unprecedented water flow in the Saptakoshi river triggered widespread destruction, with Bagmati being the most severely affected province. The disaster resulted in 249 deaths, 177 injuries, and the displacement of 10,807 families. Additionally, 5,996 houses were fully destroyed, 13,049 were partially damaged, and 16,241 families were affected - with vulnerable groups disproportionately impacted. Overall damage is estimated at NPR 46.7 billion (0.8 percent of FY25 GDP), spanning infrastructure, agriculture, and social sectors, underscoring the need for urgent recovery and reconstruction efforts. The floods inflicted extensive damage across key sectors. Infrastructure losses amounted to NPR 38.9 billion, including roads (NPR 28 billion), hydropower facilities (NPR 3 billion), telecommunication units (NPR 152.3 million), water supply and sanitation systems (NPR 5.9 billion), and bridges (NPR 1 billion). The agricultural sector suffered NPR 7.2 billion in losses, with vast farmland submerged, crops destroyed, and heavy livestock casualties. The education and health sectors also faced significant disruptions, with damages totaling NPR 91.9 million due to affected schools and health facilities. Box 2. Tribhuvan International Airport Upgrade Tribhuvan International Airport (TIA), Nepal’s sole international gateway, is undergoing a substantial upgrade to address rising air traffic and meet international safety standards. The NPR 15 billion project, initiated on November 8, 2024, and slated for completion by March 31, 2025, is funded by the Nepali government and international institutions like the Asian Development Bank. This upgrade aims to enhance passenger experience, improve operational efficiency, and ensure compliance with global aviation norms. Key improvements include runway expansion, additional parking bays, new taxiways, expanded apron space, and upgraded air traffic control systems. To minimize disruption, construction is scheduled during nighttime closures, focusing on excavation and taxiway development. Despite strategic phasing, the upgrade has impacted TIA’s operations, resulting in flight delays, cancellations, and a 30–35 percent reduction in domestic flights. Temporary safety restrictions, such as reduced apron parking, are (contribution to GDP growth, percentage points) in place throughout the construction period. The upgrade has caused disruptions, Agriculture including Industry reduced Services operating hours GDP at basic prices 6 and inflated ticket prices, as there was no alternative airport for international flights. This has affected tourism activities with the number of tourist arrivals declining from 293,417 in the first 4 quarter of FY25 to 286,526 in the second quarter of FY25. 2 0 Gross Domestic Product by Industrial Figure 2. Services sector growth slightly slowed down in -2 1 H1FY25 due to a slower growth in financial and insurance Classification H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 activities, as well as accommodation and food service. The services sector grew by 5.1 percent in H1FY25, slightly (contribution to services GDP growth, percentage points) below the 5.2 percent recorded in H1FY24 (Figure 2). Wholesale and retail trade Transportation and storage Accomodation Real estate activities This slowdown was primarily driven by weaker growth in Others Financial and insurance activities Services GDP financial and insurance activities, which declined from 12.9 6 percent in H1FY24 to 5.9 percent in H1FY25, reflecting excess 4 2 liquidity, weak credit demand, and rising non-performing 0 loans. Similarly, accommodation and food services growth -2 dropped sharply from 27.2 percent to 5.3 percent, mirroring 2 -4 a significant slowdown in the growth of tourist arrivals—from H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 45.8 percent in H1FY24 to just 3.6 percent in H1FY25—partly due to tourism disruptions caused by the upgradation of TIA Source. NSO and World Bank staff calculations. THE WORLD BANK | 11 RECENT ECONOMIC DEVELOPMENTS (Box 2). However, wholesale and retail trade helped offset The agricultural sector grew by 3.6 percent in H1FY25, up these declines, accelerating from 1.4 percent in H1FY24 to from 2.2 percent in H1FY24. This was driven by a 4 percent 4.5 percent in H1FY25, supported by an increase in nominal increase in main season paddy production (Figure 5) and merchandise imports. Transportation and storage also a 5.8 percent increase in paddy yield supported, in turn, by provided a boost, expanding by 12.9 percent, up from 9.5 improved seed availability and favorable weather conditions. percent in H1FY24. A significant increase in paddy production occurred despite the September 2024 flood due to “above-normal rainfall,” The industrial sector expanded by 6.6 percent in a longer monsoon season, as the country’s food baskets, H1FY25, higher than the 5.3 percent growth recorded mainly the southern Tarai belt, was less affected by the flood. in H1FY24 (Figure 3). This growth was primarily driven by However, despite higher yield, Nepal remains reliant on rice the electricity sub-sector, which surged by 15.1 percent in imports. Following the removal of India’s restrictive measures H1FY25, reflecting the increase in hydroelectricity installed on rice exports, rice imports rose significantly in H1FY25 (see capacity from 151 MW in H1FY24 to 244 MW in H1FY25. While External Sector section). it maintained strong performance, this was lower than the 24.7 percent growth in H1FY24 (Figure 4). Additionally, the Figure 5. Agriculture expanded due to the increased manufacturing sub-sector showed notable improvement, production of paddy in H1FY25. with growth accelerating to 5.3 percent in H1FY25, up from a (paddy production, metric tons) (contrib contraction of 1.2 percent in H1FY24. This improvement was 6200 driven in part by increased production of refined edible oils 6000 and alcoholic beverages. In contrast, the construction sub- 5800 sector remained unchanged, maintaining a growth rate of 5 5600 5400 percent in H1FY25, consistent with H1FY24. 5200 5000 Figure 3. Industrial sector growth accelerated in H1FY25, 4800 -0.5 driven by the electricity and manufacturing sub-sectors. 4600 5 -1.0 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 (contribution to industry GDP growth, percentage points) Construction Source. Ministry of Agriculture and Livestock Development and World Bank Water supply; sewerage, waste management staff calculations. Electricity, gas, steam and air conditioning supply (contribution to headline inflation, percentage points) Manufacturing Food and beverage Housing and utilities Mining and quarrying 2.0 Industry Gross Domestic Product by Demand Restaurant and hotel Nepal overall inflation Other non-food 2and services India overall inflation 1.5 9 (contribution 1.0 to industry GDP growth, percentage points) Construction Private 8 investment growth in H1FY25 remained sluggish. 0.5 0.0 Water supply; sewerage, waste management Despite 7 a 9.2 percent year-on-year increase in nominal capital Electricity, gas, steam and air conditioning supply 6 -0.5 Manufacturing and 5 intermediate goods imports, consistent with historical -1.0 Mining and quarrying 4 3 H1FY19 H1FY20 Industry H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 average 3 from H1FY17 to H1FY24, this has not translated to 2.0 1.5 6 a significant 2 private investment growth. Moreover, non- 1.0 (additional 1 Source. 0.5 NSOinstalled capacity, and World Bank megawatt) staff calculations. financial 0 business credit growth was a modest 6 percent, 0.0 700 H1FY19 H1FY20 far below the 17.9 percent H1FY21 H1FY22 average from H1FY23 H1FY24 H1FY17 to H1FY25 H1FY24, Figure -0.5 600 4. Higher hydroelectric production supported the -1.0 reflecting weak domestic demand and indicating a subdued industrial 500 H1FY19 sector’s H1FY20 growth H1FY25. H1FY21in H1FY22 H1FY23 H1FY24 H1FY25 3 400 investment climate. 300 (additional installed capacity, megawatt) 200 Public consumption followed a downward trend. 700 100 High-frequency data indicate a decline in nominal public 600 0 500 consumption in H1FY25 due to reduced spending on goods H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 4 400 and services. In contrast, nominal public investment saw 300 an increase in H1FY25, albeit significantly lower than the 200 average growth recorded during H1FY17-H1FY24. 100 0 Exports of goods and services contributed to economic H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 4 growth; however, the pace of growth slowed in H1FY25. Source. Department of Land Management and Archive and World Bank In nominal terms, exports of goods and services increased by staff calculations. 2 The demand-side growth analysis is conducted in nominal terms due to data availability constraints. 12 NEPAL DEVELOPMENT UPDATE | APRIL 2025 (paddy production, metric tons) (contributi 7.7 percent in H1FY25 lower than the average growth of 10.2 accounts for 16.7 percent of the overall consumer basket, percent6200 over H1FY17-H1FY24 and 9.9 percent in H1FY24. This along with restaurant and hotel services, which account for 8 6000 slowdown was driven by a 2.2 percent contraction in services percent, contributed significantly to this decline. exports in H1FY25, compared to a 27.1 percent expansion in 5800 In contrast, food and beverage inflation inched up by 0.2 H1FY24. 5600 percentage points, remaining elevated at 7.5 percent. Inflation moderated in the first half of FY25 due to lower non- The vegetable component, which carries a 5 percent weight 5400 food and services prices in the consumer basket, surged by 26.6 percent, driving the 5200 increase in food and beverage inflation. This is despite the Average headline inflation eased to 5 percent in H1FY25, removal of value-added tax on potatoes, onions, apples, and 5000 6.5 percent in H1FY24, aligning with the down from other vegetables and fruits through the FY25 budget, aimed FY25 inflation ceiling and marking the second NRB’s 4800 at supporting domestic production. This trend also mirrors lowest level since H1FY21 (Figure 6). This moderation was -0.5 4600 developments in India, where vegetable inflation rose by primarily driven by a reduction in non-food and services -1.0 5 H1FY19 inflation, which H1FY20 fell from 5.9 H1FY21 percent in H1FY24 H1FY22 the H1FY23 same rate in H1FY25. to 3.6 percent H1FY24 Given H1FY25 Nepal’s currency peg with the Indian rupee, inflation trends in Nepal are closely tied to in H1FY25. The housing and utility component, which price movements in India. Figure 6. Average headline inflation eased in H1FY25 due to lower non-food and services inflation. (contribution to headline inflation, percentage points) Food and beverage Housing and utilities Restaurant and hotel Other non-food and services Nepal overall inflation India overall inflation 9 8 7 6 5 4 3 6 2 1 0 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 Source. Nepal Rastra Bank (NRB) and World Bank staff calculations. A.2 External Sector Figure 7. The current surplus moderated in H1FY25. The current account surplus moderated in H1FY25, as (as a share of GDP, percent) Export of goods and services Import of goods and services remittance inflows decreased offsetting a lower trade deficit, Remittances Others Primary income Current account balance but buffers remain adequate 20 15 10 The current account surplus (CAS) moderated from 2.8 5 0 percent of GDP in H1FY24 to 2.4 percent of GDP3 in H1FY25. -5 This reflects a decline in remittances of 0.5 percentage point -10 -15 of GDP and primary income of 0.2 percentage points of GDP -20 -25 (Figure 7 and Table 1). These decreases more than offset a 7 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 3 Throughout the text, FY25 GDP refers to the World Bank’s projected GDP. Source. NRB, NSO, and World Bank staff calculations. Foreign exchange reserves, USD billion Import coverage, months 16 14 THE WORLD BANK | 13 12 10 8 RECENT ECONOMIC DEVELOPMENTS (as a share of GDP, percent) Export of goods and services Import of goods and services Remittances Others Primary income Current account balance 20 15 0.310percentage point of GDP reduction in the trade deficit of Figure 9. Official remittance inflows decreased, reflecting 5 goods0 and services. The narrowing of the trade deficit was the delayed impact of a 26 percent drop in migrant outflows. supported -5 by a 0.2 percentage point reduction in imports as -10 (migrant workers ou�low, thousands) a share -15 of GDP and a 0.1 percentage point increase in exports. -20 UAE Malaysia Others Total -25 Figure 8. Despite moderation in current account surplus, 300 7 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 foreign exchange reserves remained robust. 250 200 Foreign exchange reserves, USD billion 150 Import coverage, months 100 16 50 14 9 0 12 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 10 8 6 Source. NRB and World Bank Staff calculations. 4 (as a share of GDP, percent) 2 0 H1FY25. However, Food & H1FY25 beverages, processed, forimports industry were at ltheir Fuels and lowest ubricants, level processed 8 Industrial supplies Other merchandise import H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 H1FY16. since Transport The decline was driven equipment by reductions Total goods import in both merchandise 25 and services imports. Source. NRB and World Bank staff calculations. 20 Merchandise 15 imports declined slightly by 0.1 percentage Official remittance inflows decreased from a record high 10 to 13 percent of GDP, primarily due a decrease in the point of 12.9 percent of GDP in H1FY24 to 12.4 percent of GDP 5 import of petroleum products (Figure 10). This drop was in H1FY25. This decline reflects the delayed impact of a 26 0 10 by both driven H1FY19 H1FY20 H1FY21 in a reduction international H1FY22 H1FY23 petroleum H1FY24 prices H1FY25 percent reduction in migrant outflows in H1FY24, primarily and decreased diesel imports4, which accounted for over 40 due to a more than 74 percent drop in Nepali workers percent of total oil imports in H1FY25. Imports of industrial migrating to Malaysia (Figure 9). The decrease was caused supplies such as fertilizers and gold also fell. Gold imports by Malaysia’s decision to cap its foreign labor force at 15 declined after Nepal raised customs duties at the start of percent of the total domestic workforce, as outlined in the the fiscal year, making gold more expensive than in India. 12th Malaysia Plan, 2021-2025 to reduce dependence on However, a reduction in customs duty in late November 2024 foreign workers. As a result, the Malaysian government froze helped limit the decline. An increase in the import of food and foreign worker quotas from March 2023 to February 2024 and beverages processed for industry contributed to reducing banned the recruitment of foreign workers starting in June the decline in merchandise imports. Rising imports of LPG, 2024, after the foreign worker limit was reached. The negative along with a surge in rice imports after India lifted export impact of this decrease in migrant workers to Malaysia was restrictions in September 2024, helped prevent a sharper fall somewhat offset by an increase in Nepali migrant workers in merchandise imports. Similarly, higher imports of crude moving to the UAE and other destinations. edible oil for re-export purposes to India also contributed, Imports of goods and services, as a share of GDP, slightly following India’s decision to raise import duties on crude and fell from 15.8 percent in H1FY24 to 15.6 percent of in refined edible oils in September 2024, while Nepal benefited Table 1. Selected External Sector Indicators (percent of GDP)   H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 Current Account Balance -3.9 -2.0 -1.2 -7.1 -0.7 2.8 2.4 Balance of Goods and Services -17.3 -15.9 -14.0 -17.9 -13.3 -12.1 -11.8 Total Exports of Goods and Services 3.8 4.0 2.3 3.5 3.4 3.7 3.8 Total Imports of Goods and Services 21.1 19.9 16.3 21.5 16.7 15.8 15.6 Remittances 11.5 11.5 11.4 9.5 10.9 12.9 12.4 Net Foreign Direct Investment 0.1 0.3 0.2 0.2 0.0 0.1 0.1 Gross Official Reserves (USD billion) 9.4 9.7 12.8 9.9 10.3 13.7 16.8 Source: NRB, NSO, and World Bank staff calculations. 4 The decrease in diesel imports could reflect the increased usage of electric vehicles. 14 UAE Malaysia Others Total 300 250 NEPAL DEVELOPMENT UPDATE | APRIL 2025 200 150 100 50 9 0 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 Figure 10. Merchandise imports declined due to a Exports of goods and services increased slightly by decrease in the import of petroleum products. 0.1 percentage points of GDP to 3.8 percent of GDP (as a share of GDP, percent) in H1FY25, driven by higher merchandise exports. Food & beverages, processed, for industry Fuels and lubricants, processed Merchandise exports rose from 1.7 percent of GDP in H1FY24 Industrial supplies Other merchandise import Transport equipment Total goods import to 1.9 percent of GDP in H1FY25, mainly due to a surge in 25 refined edible oil exports, notably soybean and sunflower oil 20 (Figure 12). This increase was supported by India’s tariff hikes 15 on refined edible oil, which encouraged Nepali traders to 10 5 leverage zero-duty access under SAFTA. Conversely, exports 0 of Nepal Trade Integration Strategy (NTIS) 2023 products5 10 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 declined. Exports of cement, footwear, and various other (as a share of GDP, percent) Source. NRB and World Bank staff calculations. products to India remain restricted due Transport to prolonged delays Educational travel Note: Goods imports do not include electricity imports. and stringent hurdles in obtaining or renewing Non-educational travel Insurance the and pension Bureau services Others Total services import of Indian 3.0 Standards (BIS) certification. Electricity exports 2.5 from zero-duty access to the Indian market under the South also fell following a reduction in electricity production after 2.0 Asian Free Trade Agreement (SAFTA). Among major non- September 2024 floods, which damaged Nepal’s largest the1.5 oil, non-gold, and non-food imports, transport equipment 1.0 456-megawatt hydropower project for nearly three months. 0.5 (mainly electric vehicles) and iron and steel (industrial 0.0 supplies) increased. 11 12. Merchandise Figure H1FY19 H1FY20 exports H1FY21 H1FY22 rose due H1FY24 H1FY23 H1FY25 in to a surge refined edible oil exports. Services imports also fell by 0.1 percentage points to 2.6 (as a share of GDP, percent) percent of GDP in H1FY25, mainly due to lower transport Total NTIS export Palm oil export - refined service imports, reflecting a decrease in Nepalis traveling Soyabean oil export - refined Sunflower oil export - refined Other non-NTIS export Total goods export abroad (Figure 11). This decline could partly be attributed to 3.0 flight disruptions caused by the partial closure of Tribhuvan 2.5 International Airport for upgrades from November 8, 2024, 2.0 1.5 to the end of March 2025. Educational service imports 1.0 have exceeded transport service imports since H1FY24 and 0.5 remained the largest component, staying high at around 0.0 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 0.9 percent of GDP in H1FY25. Over 40,000 no-objection 12 certificates (NOCs) were issued by the Ministry of Education Source. Department of Customs, NRB, and World Bank staff calculations. in H1FY25 for students planning to study abroad. Note: Goods exports do not include electricity exports. Figure 11. Service imports also fell due to a reduction in Figure 13. In contrast, services exports declined due to transport service imports. reductions in travel and transport services. (as a share of GDP, percent) (as a share of GDP, percent) Transport Transport Educational travel Travel Non-educational travel Insurance and pension services Telecommunication, computer and information Others Total services import Government goods and services n.i.e. 3.0 Other services 2.5 Total services export 3.0 2.0 2.5 1.5 2.0 1.0 1.5 1.0 0.5 13 0.5 0.0 0.0 11 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 Source. NRB and World Bank staff calculations. Source. NRB and World Bank staff calculations. (as a share of GDP, percent) (August 2002=100) Total NTIS export Palm oil export - refined NEER REER Soyabean oil export - refined Sunflower oil export - refined 150 Other non-NTIS export Total goods export 140 3.0 130 2.5 120 Lokta Paper, Iron and Steel, Jewellery, Jute, Lentils, Medicinal and Aromatic 5 This includes All Fabrics, Textile, Yarn and Rope, Cardamom, Carpet, Footwear, Ginger, Handmade 2.0 110 Plants, Pashmina, Pasta, Readymade Garments, Rosin and Turpentine, Tea, Woolen Items (including Felt). 1.5 100 1.0 90 80 0.5 70 THE WORLD BANK | 15 0.0 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 14 12 RECENT ECONOMIC DEVELOPMENTS In contrast, services exports declined slightly by 0.1 of GDP in H1FY25, the highest level since H1FY22, driven percentage points to 1.9 percent of GDP in H1FY25, driven by increase in net external borrowing from sectors outside by reductions in travel and transport services (Figure 13). the central bank, government, and banking and financial This reflected a slowdown in the pace of growth in tourist institutions. In contrast, net foreign direct investment (FDI) arrivals. Meanwhile, exports of ICT services and other remained minimal, accounting for less than 0.1 percent government goods and services increased. Additionally, of GDP. Despite a moderation in the CAS surplus, robust professional and management consulting services, financing flows, contributed to continued pick up in foreign categorized under other services, also saw an increase. exchange reserves, covering 14.4 months of goods imports by the end of H1FY25, compared to 12.1 months in H1FY25— The Nepali Rupee (NPR) appreciated in H1FY25, well above the policy minimum of 7 months. reflecting gains in both the nominal effective exchange rate (NEER) and the real effective exchange rate (REER) (Figure 14). (as a share of GDP, average of nominal The NEER, calculated as the geometric weighted percent) Transport A.3 Monetary and Travel bilateral exchange rates between the NPR and a basket Telecommunication, computer and information of currencies Government servicesmajor goods andfrom n.i.e. trading partners, Financial Sector Other services rose slightly by Total percent 0.9 services export in H1FY25. The REER, which 3.0 adjusts the NEER for inflation differentials, appreciated more Monetary policy remained accommodative in H1FY25 2.5 2.0 significantly by 2.5 percent, indicating that domestic inflation 1.5 According to the FY25 monetary policy statement of Nepal outpaced that of its major trading partners. in1.0 the central bank, the official monetary policy stance 13 0.5 Figure 0.0 14. The nominal effective exchange rate and the is cautious yet accommodative balancing the need H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 real effective exchange rate both appreciated. to stimulate economic activity with the imperative of preserving macroeconomic stability. This approach was (August 2002=100) underpinned by robust foreign exchange reserves, sufficient NEER REER to cover 13 months of imports by the end of FY24, and a 150 140 benign inflation environment. Consequently, on July 26, 130 2024, the central bank reduced the policy rate and the upper 120 110 bound of the interest rate corridor by 50 basis points each, 100 setting them at 5 percent and 6.5 percent, respectively, while 90 80 maintaining the lower bound at 3 percent (Figure 15). This 70 adjustment followed a series of policy rate reductions in H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 14 FY24, totaling 1.5 percentage points, with initial cuts of 50 Source. World Bank Staff calculations. basis points in July 2023 and a further 100 basis points in December 2023. The Nepal Country Economic Memorandum (CEM6) highlights that the appreciation of bilateral real These rate reductions in both FY24 and H1FY25, exchange rates (RER), driven in part by rising coupled with subdued credit demand, contributed to a remittances, has significantly undermined Nepal’s export substantial accumulation of excess liquidity within the competitiveness, leading to an estimated 10 percent market. To address this, the central bank actively engaged decline in exports since 2011. The analysis underscores in open market operations, absorbing approximately NPR the critical need for authorities to curb inflationary pressures 14 trillion (net), predominantly through the standing deposit to prevent further REER appreciation. Key policy measures facility introduced in mid-February 2024. This marked a include fostering greater market competition in essential significant increase from the NPR 4 trillion (net) absorbed in non-tradeable sectors such as transportation and logistics, as FY24 and the NPR 200 billion (net) injected in H1FY24 (Figure well as channeling remittances into productive investments 16). The standing deposit facility allowed banks to deposit that drive sustainable economic growth rather than fueling surplus funds at the deposit collection rate, reducing their inflationary consumption. reliance on traditional liquidity instruments and effectively maintaining the interbank rate close to the lower bound of Foreign exchange reserves remain adequate, covering the interest rate corridor (Figure 15). over 14 months of goods and services imports (Figure 8). Net external borrowing, encompassing both private and Nominal interest rates still fell in H1FY25 due to concessional public borrowing, reached a peak of 0.9 percent monetary easing and weak credit demand, although 6 See https://documents.worldbank.org/en/publication/documents-reports/documentdetail/099032125103030263 for details. 16 NEPAL DEVELOPMENT UPDATE | APRIL 2025 Figure 15. The central bank cut the policy rate at the beginning of FY25. (weighted average, percent) Interbank rate Upper bound rate Lower bound rate Policy rate 10 9 8 7 6 5 4 (weighted average, percent) 3 2 Interbank rate Upper bound rate Lower bound rate Policy rate 10 9 1 8 0 7 Jun-23 Jul-24 Apr-21 Jun-20 Jun-21 Apr-20 Apr-22 Jun-22 Nov-23 May-24 Nov-24 Apr-23 Aug-19 Dec-19 Feb-20 Dec-20 Aug-21 Dec-21 Mar-24 Aug-20 Aug-23 Jan-24 Feb-21 Feb-22 Dec-22 Sep-24 Jan-25 Aug-22 Feb-23 Oct-19 Oct-20 Oct-21 Oct-23 Oct-22 6 5 4 3 2 1 Source. NRB and World Bank staff calculations. 0 15 Jun-23 Apr-21 Jul-24 Apr-20 Jun-20 Jun-21 Apr-22 Jun-22 Apr-23 Nov-23 May-24 Nov-24 Aug-19 Dec-19 Feb-20 Aug-20 Dec-20 Feb-21 Aug-21 Dec-21 Feb-22 Aug-22 Dec-22 Aug-23 Jan-24 Mar-24 Sep-24 Jan-25 Feb-23 Oct-19 Oct-20 Oct-21 Oct-22 Oct-23 Figure 16. The central bank absorbed excess liquidity Figure 17. Nominal interest rates declined due to (liquidity injection(+) through the standing deposit facility. and absorption (-), NPR billion) easing and subdued credit demand. monetary 15 Overnight liquidity facility (OLF) Standing liquidity facility (SLF) (liquidity injection(+) and absorption (-), NPR billion) Deposit auction (percent) Standing deposit facility (SDF) Overnight liquidity facility (OLF) Standing liquidity facility (SLF) Interest rate on deposit Lending rate Base rate Deposit auction Standing deposit facility (SDF) Others Net absorption Others Net absorption 15 Net liquidity Net liquidity 6,000 6,000 12 (percent) 3,000 3,000 0 9 Interest rate on deposit Lending rate Base rate -3,000 -6,000 0 15 6 -3,000 -9,000 -12,000 17 12 3 -6,000 -15,000 90 16 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 -9,000 6 -12,000 Source. NRB and World Bank staff calculations. 17 3 Source. NRB and World Bank staff calculations. -15,000 0 (deposits by source, as a share of GDP, percent) H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 the central 16 bank’s active H1FY19 liquidity management H1FY20 H1FY21 Figure H1FY22 18. Deposits H1FY23 increased H1FY24 despite Total deposits H1FY25 the Real interest decline rate (RHS) in real through open market operations and the standing interest 120 rate. 2.5 deposit facility helped moderate the decline. Deposit 100 2.0 80 by source, as a share of GDP, percent) (deposits rate of commercial banks fell by 2.6 percentage points, 1.5 60 Total deposits Real interest rate (RHS) contributing to a 2.7 percentage point decline in the average 120 1.0 2.5 40 base rate and weighted lending rate (Figure 17). By the end 100 0.5 20 2.0 of H1FY25, lending rates had reached a historic low of 8.7 80 0 0.0 1.5 18 percent. 60 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 1.0 40 Real interest rates, while remaining positive, also 20 0.5 declined in H1FY25, in line with the downward trend of 0 0.0 18 both nominal and inflation rates. Nevertheless, deposits H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 as a share of GDP increased by 1.8 percentage points to reach Source. NRB, NSO, and World Bank staff calculations. 108.7 percent by the end of H1FY25 (Figure 18). This increase was primarily driven by individual deposits, which constitute over 60 percent of total deposits, with a rise in savings deposits more than offsetting a decline in fixed deposits. THE WORLD BANK | 17 RECENT ECONOMIC DEVELOPMENTS (as a share of GDP, percent) Others Working capital loan Margin nature loan Deprived sector loan Trust receipt loan / import loan Term loan Total 120 Conversely, despite the record-low lending rates, private This expansion was primarily driven by a surge in foreign 100 sector credit declined by 1.2 percentage points of GDP, assets, 80 supported by a current account surplus, as detailed reaching 93.6 percent by the end of H1FY25, the lowest 60 External Sector section. in the 40 level since H1FY21 (Figure 19). This decline reflects, in 20 part, subdued domestic demand (see Real Sector section). Figure 0 20. Broad money supply (M2) expanded due to an 19 Product-wise credit data indicates that this was driven by H1FY20 assets. increase in foreign H1FY19 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 reductions in deprived sector loans7 and working capital (as a share of GDP, percent) loans (overdraft loans, cash credit loans, and demand and Net foreign assets Claims on private sector Others Broad money (M2) other working capital loan). A significant factor impacting 200 deprived sector loans was also the introduction of a limit 150 in October 2024, restricting licensed financial institutions 100 from lending more than 40 percent of their total wholesale 50 lending to any single microfinance institution. While total 0 working capital loan declined, term loans increased as -50 -100 working capital financing was restructured from revolving 20 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 to terminating loans. Import loans and margin nature loans Source. NRB, NSO, and World Bank staff calculations. also increased, moderating the overall decline in private sector credit. The rise in margin nature loans was partly due to the exemption of the maximum single obligor limit for The financial sector8 faced growing pressures on asset quality, institutional investors, effective August 2024. profitability, and capital adequacy The financial sector’s asset quality continued to Figure 19. Despite the record-low lending rate, private deteriorate, with the non-performing loans (NPLs) ratio sector credit contracted. climbing to a record high of 4.9 percent by the end of (as a share of GDP, percent) H1FY25 (Figure 21). This rise in NPLs was widespread Others Working capital loan Margin nature loan Deprived sector loan across commercial banks, development banks, and finance Trust receipt loan / import loan Term loan companies, with the latter experiencing the sharpest Total 120 deterioration. This trend may be driven by several factors, 100 80 including weak domestic demand, the enduring impact of 60 COVID-19, inadequate risk management practices, and a 40 decline in loan quality. NRB’s August 2024 policy intervention, 20 0 which permitted the restructuring and rescheduling of loans 19 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 in key sectors such as hydropower, hotels, and poultry farming, played a crucial role in mitigating what could have Source. NRB, (as a share NSO, of GDP, and World Bank staff calculations. percent) Net foreign assets Claims on private sector been an even sharper surge in NPLs. Others Broad money (M2) The central bank has introduced several policy measures 200 Figure 21. The financial sector’s asset quality deteriorated, with to stimulate credit expansion. This includes (i) extending 150 the decline being more pronounced for finance companies… access 100 to lower-interest loans for sectors promoting domestic production; 50 (ii) allowing investments in energy bonds to (NPL ratio, percent) Commercial banks Development banks count 0 towards mandatory sectoral investment requirements; Finance companies Overall increasing the credit limit for micro, cottage, small, and (iii) -50 14 -100 20medium 12 enterprises H1FY19 H1FY20 (MSMEs) H1FY21 from NPR H1FY22 10 million H1FY23 H1FY24 to NPR H1FY25 20 10 million; and (iv) extending the implementation timeline of 8 the working capital guidelines’ variance analysis provision 6 by one year from FY26. 4 2 Finally, despite the decline in private sector credit, the 0 21 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 broad money supply (M2) expanded by 2.2 percentage points to reach 117.5 percent of GDP in H1FY25 (Figure 20). Source. NRB and World Bank staff calculations. (as a share of GDP, percent) Loan loss provision Net profit Net interest income 7 In Nepal, financial institutions are required to allocate at least 5 percent of their overall credit to deprived sectors, which include economically disadvantaged and underserved groups, such as socially disadvantaged women, marginalized communities, and small farmers,2.5 among others. 8 The financial sector includes commercial banks, development banks, and finance companies. 2.0 1.5 18 1.0 0.5 (NPL ratio, percent) Commercial banks Development banks Finance companies Overall 14 12 NEPAL DEVELOPMENT UPDATE | APRIL 2025 10 8 6 4 2 Figure 0 22. ...leading to an increase in loan-loss provisions Figure 23. The financial sector’s capital adequacy ratio H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 21 and lower profitability. remained above the regulatory minimum requirement. (CAR, percent) (as a share of GDP, percent) Commercial banks Development banks Loan loss provision Net profit Net interest income Finance companies Overall 22 2.5 20 2.0 18 1.5 16 14 1.0 12 0.5 10 0.0 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 23 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 22 Source. NRB and World Bank staff calculations. Source. NRB and World Bank staff Trading calculations. volume, share units in millions NEPSE Index Trading value, as a share of GDP (RHS) 3,500 20 The rise in NPLs led to a substantial increase in loan- Nepal’s financial markets recently experienced two significant 3,000 loss provisions, eroding the profitability of the financial developments: 2,500 the issuance of a sovereign rating and the15 grey 2,000 sector (Figure 22). In H1FY25, net profits of commercial listing by the Financial Action Task Force. 1,500 10 banks, development banks, and finance companies declined 1,000 5 several years of effort, Nepal received its first After 500 by 2.9 percent as loan-loss provisions on non-performing 0 0 sovereign 24 credit rating from Fitch Ratings in November loans surged by 15.5 percent, compared to 3.7 percent for H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 2024. Fitch assigned Nepal a Long-Term Foreign-Currency performing loans. The NPR 4.2 billion increase in provisions Issuer Default Rating (IDR) of ‘BB-’ with a Stable Outlook. for non-performing loans, fueled by deteriorating asset The rating reflects both strengths and weaknesses. Among quality, more than offset the NPR 3.1 billion decline in net the strengths are Nepal’s low and highly concessional interest income. To mitigate this impact, the NRB introduced external public debt, strong foreign exchange reserves, targeted measures during H1FY25, including lowering and solid medium-term growth prospects, particularly provisioning requirements for ‘good loans’ and facilitating driven by the hydropower sector. However, Nepal also faces the restructuring of loans in key sectors such as hydropower, several weaknesses. Its governance indicators, especially in hotels, and poultry farming. Total loan-loss provision Government Effectiveness and Regulatory Quality, are weaker coverage stood at 104.7 percent of non-performing loans in than the ‘BB’ median, and its GDP per capita, at around USD H1FY25. 1,400, is significantly below the ‘BB’ average. Additionally, Despite these challenges, the financial sector maintained the country’s government revenues, at 19 percent of GDP, are a capital adequacy ratio (CAR) of 12.4 percent by the relatively low compared to its ‘BB’ peers.9 A sovereign credit end of H1FY25, with commercial banks, development rating can facilitate Nepal access to international capital banks, and finance companies recording CARs of 12.3, markets for mobilizing additional resources for economic 12.6, and 13.1 percent, respectively (Figure 23). To further development, provided that the rating is maintained and support capital adequacy and safeguard financial stability, improved over time. NRB introduced additional forbearance measures, including: (i) reducing the loan-loss provisioning requirement for In parallel, Nepal was added to the Financial Action ‘good loans’ from 1.2 percent to 1.1 percent; (ii) setting the Task Force (FATF) Grey List on February 21, 2025, due to countercyclical buffer for FY25 at zero percent, down from the concerns about weaknesses in its financial system, including previous 0.5 percent; (iii) raising the regulatory retail portfolio ineffective regulatory enforcement, and insufficient (RRP) limit from NPR 20 million to NPR 25 million; and (iv) implementation of anti-money laundering and combating allowing BFIs to include accrued interest receivables on pass the financing of terrorism (AML/CFT) policies. While the loans and interest capitalized reserves in Tier 2 capital. government has committed to corrective measures, effective 9 See https://www.fitchratings.com/research/sovereigns/fitch-assigns-nepal-bb-idr-outlook-stable-21-11-2024 for details THE WORLD BANK | 19 RECENT ECONOMIC DEVELOPMENTS implementation has been lacking and remains a key percent capital gains tax, while long-term investors benefited challenge. Indeed, of FATF’s 40 key recommendations, Nepal from a lower rate of 5 percent. To further bolster the stock has fulfilled only 21. This marks the second time that Nepal market and incentivize institutional investment, the NRB has been placed on the Grey List; the first time happened removed the maximum single obligor limit for institutional during 2008 and 2014. investors, which was previously capped at NPR 150 million. The consequences of being on the Grey List for Nepal can be significant and include (i) restricted cross-border A.4 Fiscal Sector transactions, potentially reducing official remittance inflows; (ii) reduced foreign investment, due to heightened perceived Nepal’s fiscal deficit narrowed sharply, with revenue growth risks; (iii) higher transaction costs for financial institutions outpacing a decline in spending, in H1FY25, while public debt facing increased scrutiny from regulators. In addition, it remained sustainable damages international reputation, impacting tourism and trade partnerships. As a result, this hampers Nepal’s recent The fiscal deficit narrowed significantly by 0.46 efforts to access international capital markets. However, this percentage points of GDP, reaching near balance at can also be an opportunity for critical reforms to support the 0.01 percent of GDP in H1FY25 (Figure 25). The reduction country’s financial sector and boost economic growth. The in the fiscal deficit in H1FY25, compared to H1FY24 was country has a two-year deadline to implement reforms, and primarily driven by revenue growth and continued decline in the authorities have committed to doing so and existing the expenditure as share of GDP. Grey List before the deadline. Figure 25. Higher revenue led to a reduction in the fiscal deficit in H1FY25. Nepal’s stock market remained volatile in H1FY25. (as a share of GDP, percent) The Nepali stock market exhibited considerable volatility Revenue and grants Expenditure Fiscal balance (RHS) in H1FY25 (Figure 24). The Nepal Stock Exchange (NEPSE) 15 5.0 index surged by an impressive 33.9 percent in the first month 10 4.0 3.0 of FY25, approaching its June 2021 peak, a rise fueled by 5 2.0 lower lending rates. Subsequently, however, the market 0 1.0 underwent a correction, declining by 13.6 percent by the -5 0.0 end of H1FY25. This volatility notwithstanding, trading value 25 -10 -1.0 and volume experienced remarkable growth, surging by -15 -2.0 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 over 200 percent and 300 percent, respectively, indicating a significant (CAR, percent) increase in market activity. This heightened Source. Ministry of Finance (MoF) and World Bank staff calculations. Commercial banks Development banks (as a share of GDP, percent) activity translated increase in capital into a substantial Overall VAT Excise 22 Finance companies Revenue (including grants) increased Personal income taxes from 9.1 percent of Corporate income taxes gains tax revenue, which rose by over 80 percent compared 20 GDP in H1FY24 to 9.3 percent of GDPNon-tax Customs in H1FY25 (Figure 26). revenues to the same period in the previous year. Notably, individual Other Total revenue and grants 18 14 increase was primarily driven by (a) an increase in both This investors accounted for over 88 percent of this increase, with 12 16 import-based 10 and domestic excise duties increased. Import- a significant portion, 60.8 percent, comprising short-term 14 based 8 excise duties grew in part due to the higher import investors 12 (holding shares for less than a year) subject to a 7.5 26 6 volumes 4 of electric vehicles, while domestic excise duties 10 2 Figure 24. The H1FY19 H1FY20stock H1FY21 market’s H1FY24 remained H1FY22 performance H1FY23 H1FY25 rose0 with increased alcoholic beverage production and rate 23 below its June 2021 peak for most of H1FY25. increase; b) an H1FY21 H1FY20 in personal increaseH1FY22 H1FY23 income revenue, H1FY24 tax H1FY25 reflecting higher capital gains tax revenue from increased Trading volume, share units in millions transaction volumes and rising market prices of stocks; NEPSE Index Trading value, as a share of GDP (RHS) and c) an increase in non-tax revenue, supported by higher 3,500 20 3,000 dividends from financial and service-oriented institutions. 15 2,500 However, corporate income tax declined due to weaker 2,000 10 profitability of public limited companies. Furthermore, tax 1,500 1,000 5 expenditure accounted for approximately 0.7 percent of GDP 500 in H1FY25, almost entirely attributable to customs-related 0 0 24 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 exemptions, up from 0.6 percent of GDP in H1FY24. Source. Nepal Stock Exchange, NSO, and World Bank staff calculations. 20 (as a share of GDP, percent) Revenue and grants Expenditure Fiscal deficit (RHS) 15 5.0 10 4.0 NEPAL DEVELOPMENT UPDATE | APRIL 2025 3.0 5 2.0 0 1.0 -5 0.0 -10 -1.0 25 Figure -15 26. Revenue (including grants) increased, though it -2.0 not appear to be due to a lack of resources, as provincial H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 remained below the H1FY22 peak. and local governments utilized only 44.4 percent and 57.2 percent, respectively, of the fiscal transfers received from (as a share of GDP, percent) VAT Excise the federal government. This could reflect structural factors, Personal income taxes Corporate income taxes such as weak capacity of local governments, procurement, Customs Non-tax revenues (as a share of GDP, percent) Other Total revenue and grants and other challenges. federal In line with theGoods Wages and Compensation government’s and Services 14 Interest Payments Fiscal Transfer 12 actions, provincial governments Revenue sharing to SNGs also revised their spending Capital Expenditures 10 Other recurrent expenditure Total Expenditure 8 budgets downward during the mid-term review. For example, 12 26 6 Koshi 9 and Lumbini reduced their original budgets by 10.5 4 2 percent 6 and 14.2 percent, respectively. 0 3 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 Figure 27 0 28. Budget spending executions of subnational H1FY21 governments lower H1FY23 H1FY22 were of theH1FY25 H1FY24 than those federal Source. MoF and World Bank staff calculations. government in H1FY25. Expenditures decreased marginally as a share of GDP (budget execution, percent) from 9.5 percent in H1FY24 to 9.3 percent in H1FY25 Local Province Federal (Figure 27). This decrease was primarily driven by (a) lower 40 35 interest payments on domestic debt, resulting from lower 30 domestic interest rates (see Chapter 2 on monetary and 25 20 financial sector); (b) decreased fiscal transfers to provincial 15 10 and local governments, driven by a reduction in conditional 5 grants to provincial governments; and (c) reduced spending 0 28 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 on goods and services. Capital expenditure remained steady at 0.9 percent of GDP, with increased spending on road Source. MoF, NRB, and World Bank staff calculations. and bridge construction, partly due to higher FY25 budget allocations. Despite this, capital expenditure continued to be Figure 29. Public debt remained moderate and lower than debt servicing expenditure since H1FY22, with the sustainable. gap widening from 0.2 percent of GDP in H1FY22 to 2 percent (as a share of GDP, percent) of GDP in H1FY25. Domestic debt External debt Total debt Figure 27. Expenditures declined in H1FY25 to their lowest 50 level since H1FY21. 40 30 (as a share of GDP, percent) Wages and Compensation Goods and Services 20 Interest Payments Fiscal Transfer Revenue sharing to SNGs Capital Expenditures 29 10 Other recurrent expenditure Total Expenditure 12 0 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 9 6 Source. Public Debt Management Office (PDMO) and World Bank staff 3 calculations. (as a share of GDP, percent) 27 0 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 External borrowing Domestic borrowing Overall borrowing Narrowing 5 of the fiscal deficit led to a decline in overall Source. MoF, NRB, and World Bank staff calculations. public debt in H1FY25. Public debt had increased by 15.5 4 (budget execution, percent) percentage points of GDP between FY19 and FY24 but then 3 Spending execution Local by provincial Province and local governments Federal declined by 0.7 percentage points between H1FY24 and 40 2 was 35 lower than that of the federal government in H1FY25 H1FY25, reaching 41.1 percent of GDP in H1FY25 (Figure (Figure 30 28). Provincial governments spent only 16.2 percent 29). 1 Despite this increase over previous years, public debt 25 30 the FY25 budget, slightly up from 15.4 percent in FY24, but of20 remains 0 moderate and sustainable, with concessional H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 15 significantly 10 lower than the federal budget execution rate of public and publicly guaranteed external debt accounting 5 percent. Local governments spent only 24.7 percent of 34.4 for 51.3 percent of total public debt in H1FY25 (Table 2). The 0 H1FY20 inH1FY21 their budgets 28 a slight decrease H1FY25, H1FY22 H1FY23 H1FY24 25.3 from percent H1FY25 remaining debt stock is domestic public debt denominated in the same period of FY24. The lower budget execution does in local currency, mainly comprising development bonds and THE WORLD BANK | 21 (as a share of GDP, percent) Domestic debt External debt Total debt 50 RECENT ECONOMIC DEVELOPMENTS NEPAL DEVELOPMENT UPDATE 40 30 20 29 10 0 Treasury bills. By the end of H1FY25, banking and financial 30. The Figure H1FY19 government H1FY20 relied primarily H1FY21 H1FY22 on domestic H1FY23 H1FY24 H1FY25 institutions held nearly 94.3 percent of domestic public debt, borrowing during H1FY25. slightly lower than 94.6 percent in H1FY24. (as a share of GDP, percent) In H1FY25, the government relied primarily on domestic External borrowing Domestic borrowing Overall borrowing borrowing, taking advantage of lower market interest 5 rates. The government borrowed a record-high 2.9 percent 4 of GDP, exceeding external borrowing of 1 percent of GDP 3 In H1FY25 (Figure 30). Debt amortization increased by 1 2 percentage point to 2.4 percent of GDP by the end of H1FY25, 1 primarily due to higher domestic debt repayments. 30 0 H1FY19 H1FY20 H1FY21 H1FY22 H1FY23 H1FY24 H1FY25 Source. PDMO and World Bank staff calculations. Table 2. Nepal’s Stock of public debt (in billion NPR and percentage of GDP) FY23 FY24 H1FY24 H1FY25 Share Share Share Share Share Share Share Share of of of of of of of of Financing Source Stock Stock Stock Stock total GDP total GDP total GDP total GDP (%) (%) (%) (%) (%) (%) (%) (%) External 1170.2 51.0 21.9 1253.2 51.5 22.0 1185.7 49.8 20.8 1301.4 51.3 21.1 Multilateral 1029.8 44.9 19.3 1115.1 45.8 19.5 1044.4 43.9 18.3 1162.1 45.8 18.8 o/w World Bank 580.3 25.3 10.8 612.3 25.2 10.7 579.6 24.4 10.2 634.7 25.0 10.3 o/w ADB 370.1 16.1 6.9 406.1 16.7 7.1 379.2 15.9 6.6 424.9 16.8 6.9 o/w IMF 52.1 2.3 1.0 63.3 2.6 1.1 58.9 2.5 1.0 62.8 2.5 1.0 Bilateral 140.5 6.1 2.6 138.1 5.7 2.4 141.3 5.9 2.5 139.4 5.5 2.3 o/w Non-Paris Club 78.9 3.4 1.5 80.7 3.3 1.4 80.7 3.4 1.4 79.9 3.2 1.3 o/w China 34.6 1.5 0.6 35.3 1.4 0.6 34.7 1.5 0.6 35.3 1.4 0.6 o/w India 39.6 1.7 0.7 40.5 1.7 0.7 40.8 1.7 0.7 39.8 1.6 0.6 o/w Paris Club 61.5 2.7 1.2 57.4 2.4 1.0 60.6 2.5 1.1 59.4 2.3 1.0 Domestic 1125.2 49.0 21.0 1180.9 48.5 20.7 1193.9 50.2 20.9 1234.7 48.7 20.0 Treasury Bills 457.8 19.9 8.6 403.7 16.6 7.1 413.3 17.4 7.2 352.6 13.9 5.7 Development Bonds 656.4 28.6 12.3 761.9 31.3 13.4 769.8 32.3 13.5 864.8 34.1 14.0 Others 10.9 0.5 0.2 15.3 0.6 0.3 10.9 0.5 0.2 17.3 0.7 0.3 Total 2295.4 100.0 42.9 2434.1 100.0 42.7 2379.7 100.0 41.7 2536.1 100.0 41.1 Nominal GDP (NPR billion) 5348.5 5704.8 5704.8 6167.3 Nominal Exchange Rate Average (NPR/USD) 130.8 133.0 132.9 134.9 Source: PDMO for public debt data, NSO for historical GDP data, and World Bank for FY25 GDP forecast. 22 NEPAL DEVELOPMENT UPDATE | APRIL 2025 THE WORLD BANK | 23 NEPAL DEVELOPMENT UPDATE 24 NEPAL DEVELOPMENT UPDATE | APRIL 2025 B OUTLOOK, RISKS, AND CHALLENGES THE WORLD BANK | 25 B OUTLOOK, RISKS, AND CHALLENGES B.1 REAL SECTOR Nepal’s economy is projected to grow at 4.5 percent in 16th development plan—to exceed 11,700 MW of installed FY25, up from 3.9 percent in FY24, before averaging 5.4 electricity capacity by FY29 from the existing 3402 MW — percent annually in FY26-FY27 (Table 3). As a result, poverty and in the Energy Development Roadmap—to export 4000 (USD 3.65/day) is expected to decline to 5.5 percent, 4.8 MW of electricity from the existing 941 MW—are expected percent, and 4 percent in 2025, 2026, and 2027, respectively to support industrial growth. To accelerate hydroelectricity (Box 310). development for economic growth, the CEM recommends establishing a streamlined one-stop shop to simplify Nepal’s services sector is projected to be a primary driver approvals and clearances, reducing bureaucratic delays of economic growth in the medium term, with domestic for the private sector. Additionally, it calls for significant trade playing a leading role in FY25. This growth is largely investment in transmission and distribution infrastructure, predicated on an anticipated recovery in merchandise alongside measures to stimulate domestic demand for imports, which is expected to stimulate the wholesale and electricity. Furthermore, a series of policy measures aimed at retail trade services sub-sector. However, the financial supporting the construction sector, such as loan repayment sector’s contribution to growth may be subdued in FY25. The extensions, moratoriums on blacklisting, relaxed credit rating ongoing upgrade of Tribhuvan International Airport is causing requirements, and the Government of Nepal’s prioritization significant disruptions, including reduced operating hours of clearing outstanding payments to contractors, are likely to (Box 2). The phased reduction in daily operating hours— stimulate activity in this industry from FY26 onwards. from 20 hours to 14 hours beginning November 8, 2024, and then to 16 hours from February 1, 2025—is likely to impede The agricultural sector is also projected to grow in the government’s aim to attract 1.6 million international the medium term, primarily due to increased paddy visitors in FY25. Consequently, this disruption is anticipated production. A favorable monsoon season is expected to to dampen growth in the accommodation and food services result in increased paddy production, which, in turn, is sub-sectors during FY25. However, the upgrade is expected projected to boost output and drive agricultural growth to benefit the sector and support economic growth over the to 3.2 percent in FY25. Assuming that favorable monsoon medium term. conditions continue, growth in the agricultural sector is projected to reach 3.3 percent in FY27. Similarly, Nepal’s industrial sector is projected to grow in the medium term, primarily fueled by significant Inflation in Nepal is forecast to moderate over the medium expansion in the electricity and construction sectors. term. The inflation rate is projected to ease to 5 percent The 140-megawatt Tanahu hydropower project, Nepal’s in FY25, primarily supported by a deceleration in non-food third storage-type project, is expected to be completed by and beverages inflation. This downward trend is expected FY26. The government’s ambitious targets outlined in the to continue, with inflation further decreasing to an average Poverty incidence refers to the percentage of the population living below the poverty line. Poverty intensity measures the average degree of deprivation experienced by those 10 considered poor, reflecting the extent to which individuals fall below the poverty line and the severity of their poverty. 26 NEPAL DEVELOPMENT UPDATE | APRIL 2025 Table 3. Macroeconomic projections of selected key indicators. (annual percent change unless indicated otherwise) FY22 FY23 FY24e FY25f FY26f FY27f Real GDP growth, at constant market prices 5.6 2.0 3.9 4.5 5.2 5.5 Private Consumption 6.8 0.7 1.1 1.6 2.1 2.3 Government Consumption 9.6 -21.2 -4.2 -6.7 4.6 7.0 Gross Fixed Capital Formation 3.4 -10.0 17.0 13.7 14.7 13.4 Exports, Goods and Services 34.1 3.3 18.1 18.7 13.4 10.5 Imports, Goods and Services 16.4 -18.7 -2.3 8.5 10.3 9.1 Real GDP growth, at constant factor prices 5.3 2.3 3.5 4.5 5.2 5.5 Agriculture 2.4 2.8 3.0 3.2 3.3 3.3 Industry 10.7 1.4 1.3 4.7 6.7 7.4 Services 5.3 2.4 4.5 5.0 5.8 6.1 Inflation (Consumer Price Index) 6.3 7.7 5.4 5.0 4.5 4.3 Current Account Balance (% of GDP) -12.5 -0.9 3.9 3.6 2.8 2.4 Net Foreign Direct Investment (% of GDP) 0.4 0.1 0.1 0.2 0.2 0.3 Fiscal Balance (% of GDP) -3.2 -5.8 -2.5 -2.5 -2.8 -2.9 Revenues (% of GDP) 22.9 19.3 19.4 19.2 19.4 19.7 Debt (% of GDP) 40.5 42.9 42.7 43.2 43.3 43.4 Primary Balance (% of GDP) -2.2 -4.5 -1.0 -1.2 -1.3 -1.2 International poverty rate ($2.15 in 2017 PPP) a,b 0.4 0.3 0.2 0.2 0.2 0.1 International poverty rate ($3.65 in 2017 PPP) a,b 7.5 7.1 6.3 5.6 4.8 4.0 International poverty rate ($6.85 in 2017 PPP) a,b 44.1 43.2 40.7 38.0 35.5 32.9 Sources: MoF, NRB, and NSO for history and estimates. World Bank staff for forecasts. Notes: e =estimate; f = forecast. a/ Calculations based on SAR-POV harmonization, using 2022-NLSS-IV. Actual data: 2022. Nowcast: 2024. Forecasts are from 2025 to 2027. b/ Projection using neutral distribution (2022) with pass-through = 0.7 (Low (0.7)) based on GDP per capita in constant LCU. of 4.4 percent over FY26-27. Several factors contribute to imports and exports are projected to expand significantly, this outlook of moderating inflation. Recent data indicates driven by higher imports of crude edible oils and increased easing inflation based on the Wholesale Price Index for exports of refined edible oils, respectively. This trend H1FY25, suggesting reduced pressure from production costs. is expected to persist over the medium term. However, Second, sustained improvements in domestic agricultural electricity exports are anticipated to remain below import production, facilitated by projected favorable monsoon levels in FY25, primarily due to flood-related disruptions in conditions, are expected to play a crucial role in moderating September 2024 (Box 1). Net electricity exports are expected food price inflation. Finally, the expectation of lower inflation to increase in FY26 and FY27, supported by higher exports in India, combined with Nepal’s currency peg, is expected to to India and Bangladesh. Other merchandise imports also provide a critical buffer against imported inflation, thereby are projected to rise, reflecting robust domestic demand. further contributing to overall price stability in Nepal. Meanwhile, the services trade deficit is expected to remain unchanged at FY24 levels in FY25, as a decline in services B.2 EXTERNAL SECTOR imports offsets a decrease in services exports. The services trade deficit is projected to narrow in FY26, reflecting a rise in service exports. The trade deficit is expected to narrow in FY25 before widening over the medium term. In FY25, the trade deficit The current account surplus is projected to shrink over will decline as the increase in exports of goods and services, the medium term. A slowdown in remittance growth is as a share of GDP, outpaces that of imports. Merchandise expected due to the lagged impact of reduced migration THE WORLD BANK | 27 OUTLOOK, RISKS, AND CHALLENGES Box 3. Nepal’s poverty trends and profile Nepal has experienced a significant reduction in poverty over the past decade. The national poverty headcount rate, measured using Nepal’s new national poverty line, now stands at 20.3 percent—a significant reduction from 2010 levels. Extreme poverty (USD 2.15/day) has nearly disappeared, with the USD 3.65/day poverty rate falling to 7.5 percent in 2022 and projected to decrease further to 5.6 percent in 2025. Overall, living standards have improved across multiple dimensions, as evidenced by increased access to electricity, shorter distances to public hospitals, and more extensive paved road networks. Consumption-based inequality has also decreased slightly and remains low relative to regional and global levels, with a Gini coefficient of 30. Income-based inequality in Nepal reveals a notably unequal society, with a Gini coefficient of 44, which is relatively low by South Asian standards. However, the income of the wealthiest 10 percent of Nepalis is more than three times that of the poorest 40 percent. Emigration and remittances have played a central role in poverty reduction. However, challenges persist, including high youth unemployment rates, spatial inequalities, and vulnerabilities to economic and climate shocks, which threaten to reverse these gains. Current social assistance programs lack the flexibility needed to effectively support the poor during emergencies, highlighting the need for targeted policy measures to address these risks. Despite improvements, there are large regional disparities in poverty rates across Nepal. Poverty remains prevalent in certain regions, particularly in Sudarpaschim and Karnali provinces, where the poverty rates are 34.2 percent and 26.7 percent, respectively. Eight out of the ten municipalities with the highest poverty rates are located in these two provinces. Municipalities with the highest poverty rates are predominantly located in the hill and mountain regions underscoring how geographic targeting can guide investments. Districts like Jajarkot, Mugu, Achham, and Baitadi host municipalities with some of the highest poverty rates. This reflects deep rural poverty and low population density in these areas. In contrast, municipalities with the largest numbers of poor individuals are concentrated in the southern plains, particularly in Lumbini Province. Nepalganj Sub-Metropolitan City (Lumbini) has 49,087 poor individuals, despite a relatively moderate poverty rate of 29.9 percent. Overall, the largest number of poor are concentrated around the more populous areas of Bagmati and Lumbini provinces. Despite the higher incidence and intensity of poverty in rural areas, the concentration of the poor is greater in urban areas due to the dense population. Poverty varies significantly across provinces. Also, mountainous municipalities notably experience significantly higher poverty rates, highlighting a stark geographical divide and emphasizing the need for targeted “last-mile” efforts to reach the poor in these areas. For example, Junichande Rural Municipality (Karnali) has the highest poverty rate in the country at 77.9 percent, whereas Kathmandu Metropolitan City, despite a low poverty rate of 6.9 percent, has the largest number of poor people at 59,218. in FY24, which will contribute to a lower current account surplus in FY25, while declining remittance inflows combined B.3 FISCAL SECTOR with a widening trade deficit are likely to reduce the surplus In FY25, the fiscal deficit is projected to remain at the further in FY26 and FY27. Despite ongoing efforts to attract FY24 level of 2.5 percent of GDP. Lower revenues (including foreign investment, FDI inflows are projected to remain low. grants) are expected to be offset by reduced expenditures. Under the baseline scenario, foreign exchange reserves are Revenues and grants are forecast to decline, primarily due expected to decline but remain sufficient at prudent levels to a concerning drop in external grants11, highlighting Nepal’s (around ten months of imports by the end of FY27). increasing reliance on domestic sources. While overall The FY25 budget projects a grant of NPR 12.2 billion from the USA, with over 81 percent allocated to the Millennium Challenge Corporation (MCC). However, the mid-term 11 budget review reveals that only around 11 percent of the MCC allocation was spent in H1FY25. The remaining grants are at significant risk. 28 NEPAL DEVELOPMENT UPDATE | APRIL 2025 revenues are expected to stabilize at FY24 levels in FY25, Domestically, a further deterioration in asset quality this is contingent on higher collections from excise duties, within Nepal’s banking and financial sector presents a VAT, customs duties, and personal income tax, which are critical vulnerability. A decline in the health of financial anticipated to counteract a reduction in corporate income institutions could lead to a tightening of private sector credit, tax. Expenditures are projected to decrease in FY25, partly restricting access to capital for businesses and individuals, due to lower budget allocations for essential social programs thereby hindering investment and economic activity. such as medical allowances and goods and services. In Moreover, frequent bureaucratic reshuffles at the government contrast, capital expenditure is expected to rise following a level risk policy inconsistency and create an environment higher budget allocation. of uncertainty, severely undermining investor confidence and deterring both domestic and foreign investment. The Looking ahead, the fiscal deficit is projected to widen continued presence of Nepal on the FATF Grey List poses marginally to 2.9 percent of GDP by FY27. This widening a substantial risk. Prolonged delays in implementing deficit is driven partly by anticipated higher interest critical capital expenditure reforms represent another payments, reflecting the growing burden of debt servicing, significant domestic risk, potentially hindering infrastructure and increased capital spending, which, as noted, faces development, constraining economic efficiency, and limiting implementation challenges. Revenues are projected to long-term growth potential. increase over the medium term, but the sustainability of this increase depends heavily on the successful and timely On the upside, the economy could benefit from private implementation of the recently approved Domestic Revenue sector-led growth reforms recently introduced through Mobilization Strategy.  five ordinances, which were passed by Parliament in March 2025. These ordinances focus on critical areas such The fiscal deficit is expected to be financed through a as enhancing the business environment and investment, combination of external concessional and domestic privatization, good governance, public service delivery, borrowing. Consequently, public debt is projected to economic procedures, financial accountability, and increase from 42.7 percent of GDP in FY24 to 43.4 percent by cooperatives.13 However, the success of these reforms will FY27, remaining at sustainable levels. This forecast assumes heavily depend on their effective implementation, a challenge the government will adhere to the fiscal rule on the domestic that may persist in the medium term. A cautionary example is borrowing ceiling, as recommended by the National Natural the non-implementation of eight business law amendments Resources and Fiscal Commission and comply with the passed in the previous year, which underscores the ongoing external debt ceiling set by the Public Debt Management Act risk of reform efforts falling short of their intended impact. of 202212. Sustained economic progress will require a clear focus on prioritizing and rigorously enforcing both existing and new B.4 RISKS AND reforms. CHALLENGES Further gains could be realized by addressing key structural challenges that constrain the private sector and exports. Strengthening competition and improving The risks to the economic growth forecast for Nepal are the market structure in export-enabling sectors, particularly tilted to the downside. Externally, geopolitical uncertainties logistics and transportation, should be a priority. Targeted and the escalating trend of trade-restrictive measures pose policy measures to reduce entry barriers and enhance a serious threat. These global factors could trigger renewed efficiency in these sectors could significantly boost export and sharp surges in international commodity prices, competitiveness. Additionally, expanding access to finance particularly for essential goods like fuel and food. Such price and facilitating the adoption of digital payment systems shocks would exert widespread pressure across all sectors of would support business growth and job creation. The the Nepali economy, potentially fueling inflation, increasing digital sector, which holds strong potential, could be further production costs, and dampening consumer demand. developed by closing Nepal’s digital skills gap through Nepal’s growth model is heavily reliant on remittances and targeted education and workforce training initiatives. By tourism, so a slowdown in growth in partner countries could tackling these foundational issues, Nepal can create a more lead to a decline in both remittances and tourism, further resilient and dynamics economy and strengthen growth and hindering economic growth. job creation over the medium-term. The Acts sets the external debt ceiling at one-third of the previous year’s GDP. 12 The ordinance related to cooperatives was introduced in December 2024, while the other four ordinances, including the land-related one, were introduced in January 2025. 13 However, the land-related ordinance was not passed by Parliament due to a lack of political consensus. THE WORLD BANK | 29 NEPAL DEVELOPMENT UPDATE 30 NEPAL DEVELOPMENT UPDATE | APRIL 2025 THE WORLD BANK | 31 NEPAL DEVELOPMENT UPDATE The World Bank Nepal Country Office, P.O. Box 798 Yak and Yeti Hotel Complex Durbar Marg, Kathmandu, Nepal Tel.: 4236000 Email: infonepal@worldbank.org www.worldbank.org/np www.facebook.com/WorldBankNepal 34