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p. 21 of 33 BACK | NEXT Foreword, Acronyms and Abbreviations, Definitions I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia Southeast Asia South Asia Bangladesh India Nepal Pakistan Central Asia The Pacific III. Economic Scenarios for Asia Statistical Appendix

Asian Development Outlook 2004 Update : II. Economic Trends and Prospects in Developing Asia : South Asia

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Nepal

Economic Assessment

In FY2004 (ended 15 July 2004), the economy grew by 3.6%, somewhat lower than the 4.0% projection in ADO 2004, mainly due to the breakdown of the cease-fire with the insurgents in August 2003. Industry underperformed, expanding by only 1.8%, down from 2.3% a year earlier, due to the security situation. Growth in construction (0.3%) was particularly sluggish; however, performance of agriculture and services strengthened. Agricultural output increased by 3.7%, from the previous year’s 2.5%, boosted by favorable weather that lifted paddy production by 7.8%. Services showed a slightly better growth rate of 4.2% against 3.3% in FY2003, on account of some strengthening in tourism and strong performance of the transport, communications, and storage subsector.

On the expenditure side, gross fixed capital formation as a share of GDP continued its slide of recent years to 18.7% in FY2004--well below the average of 20.8% of GDP for the last decade. Both public and private investment shares declined, ascribable to the deterioration in the investment climate in the country. Total consumption grew by 3.0%, underpinning the expansion in GDP, based on the rise in government recurrent expenditures and private consumption that was boosted by higher worker remittances. Trends in aggregate expenditures and output indicate a recovery from the FY2002 recession, albeit anemic and fragile.

Broad money (M2) grew by 13.5% during 2004, above the 11.2% target. Weak investor confidence resulted in lower private sector credit growth than in FY2003 and in interest rates falling for the second consecutive year. Inflation was contained at 4.0%, benefiting from declining food prices.

On the external side, the improvement in the global economy helped push up exports by 13.1% to $737 million while the economic recovery, limited as it was, pushed up imports by 15.4% to $1.8 billion. The trade deficit widened slightly to 15.8% of GDP from 15.5%. Export growth was supported by a rebound in exports of woolen carpets, leather goods, and polyester yarn, which offset the decline in exports of readymade garments, vegetable ghee, and agricultural products. Import growth stemmed from 23% and 16% increases in raw material and machinery imports, respectively. The trade deficit was outweighed by stronger tourism receipts (58%), worker remittances (17%), and grants (70%). The sharply higher net surplus on the services and transfer accounts raised the current account surplus to 3.5% of GDP in FY2004 from 2.6% in FY2003. Official foreign exchange reserves climbed by 24.8% during FY2004 to $1.4 billion, providing import cover of about 10 months.

Policy Developments

Tax reforms are under way, focusing on improving administration of VAT, simplifying the Income Tax Act, implementing a 3-year customs reforms and modernization program, and establishing a large taxpayers’ office within the Inland Revenue Department. Nevertheless, stronger policy efforts are needed to broaden the tax base, especially of VAT; eliminate the wide range of tax exemptions; and address the burgeoning tax arrears, as recommended by the 2003 Fiscal Reforms Taskforce.

The Nepal Rastra Bank’s monetary policy announced in August 2004 aims to maintain low inflation and the domestic currency’s parity peg with the Indian rupee. It also targets broad money growth of 12.5% in FY2005. More widely, the policy seeks to be accommodative so as to support a fuller economic recovery and, with this in mind, reduced the mandatory cash reserve ratio from 6.0% to 5.0%.

Outlook for FY2005

Inflation is forecast to increase to 5.5% in FY2005, slightly higher than the ADO 2004 figure of 5.0%, reflecting price developments in India and continued high international oil prices. Money supply (M2) growth in FY2005 is likely to be limited to 12.5%, as targeted by the central bank. The fiscal deficit is now projected at 2.5% of GDP in FY2005, in line with the government target. ADO 2004 had forecast a higher deficit of 4.5% of GDP on the basis of greater internal security that would have allowed larger development expenditures and aid utilization.

The trade deficit is expected to widen in FY2005, mainly due to an expected decline in garment exports. Growth in tourism receipts is likely to slow. A continued expansion in worker remittances and development grants is expected to underpin the balance of payments, keeping the current account in surplus in FY2005 at the equivalent of 4.0% of GDP.

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