Press Release No. 03/194

Press Release: IMF Approves In-Principle Three-Year US$72 Million Poverty Reduction and Growth Facility Arrangement for Nepal

November 14, 2003

The Executive Board of the International Monetary Fund (IMF) today approved in-principle a three-year SDR 49.9 million (about US$72 million) Poverty Reduction and Growth Facility Arrangement for Nepal to support the country's economic reform program through July 2006. The IMF Board's decision will become effective upon a further decision following the World Bank's Executive Board review of Nepal's Poverty Reduction Strategy Paper, scheduled for November 18, 2003. At that time Nepal will be able to draw an amount equivalent to SDR 7.13 million (about US$10 million) under the PRGF arrangement.

Following the Executive Board discussion, Shigemitsu Sugisaki, Deputy Managing Director and Acting Chairman, said:

"Nepal's Poverty Reduction Strategy Paper (PRSP) is a comprehensive and participatory effort to address the country's low growth, inadequate social sector investment, and limited income opportunities for the poor. The authorities' Fund-supported reform program aims at improving the conditions for sustained growth and poverty reduction, based on sound macroeconomic policies, better prioritization and enhanced efficiency in government expenditure, structural reforms in major sectors of the economy, and improved governance. The authorities are to be commended for their strong track record of policy implementation in support of their request for Fund assistance.

"To maintain macroeconomic stability, the authorities are firmly committed to putting fiscal policy on a sound and sustainable basis. Determined implementation of tax policy measures and strengthened tax and customs administration will help mobilize additional revenue. At the same time, careful prioritization of all spending will help raise allocations for key sectors and poverty-related spending. This will need to be supported by improved capacity building efforts to enhance the efficiency and effectiveness of development spending.

"Continued implementation of financial sector reforms is critical for achieving the PRSP's objectives. The Nepal Rastra Bank will be transformed into a modern and efficient central bank, and the authorities are strengthening the commercial banking sector through enhanced debt recovery, including tightened criteria for blacklisting loan defaulters and the establishment of a Debt Recovery Tribunal. It will be important to ensure the effective and timely application of these measures to all defaulters. Progress is also being made in improving the performance of the two largest and financially troubled commercial banks through installation of external managers.

"Implementation of the authorities' structural reform agenda will be key to creating conditions for higher, private sector-led growth. This includes the privatization or liquidation of selected public enterprises, civil service reforms and decentralization measures aimed at improving service delivery. Ongoing efforts to curb corruption, including strengthening of the Commission for Investigation of Abuse of Authority and the Special Corruption Court, are welcome and will need to be sustained over time.

"The authorities are to be commended for reaching an agreement on WTO accession. To fully realize the benefits from accession, it will be important to enhance external competitiveness, including through measures that will make the labor market more flexible.

"The authorities have demonstrated their commitment to reforms through strong policy implementation under difficult circumstances, and the broad support for the PRSP strategy represents an encouraging basis for breaking the cycle of low growth, poverty, and insurgency which Nepal has faced. Nevertheless, peace and political stability will be essential to ensure that the strategy's objectives of high economic growth and broad-based poverty reduction are fully achieved, and the authorities are encouraged to make strong efforts to work toward a peaceful resolution of the conflict," Mr. Sugisaki stated.

ANNEX

Recent Economic Developments

Despite decades of development efforts supported by foreign aid, Nepal remains among the poorest countries in the world with almost 40 percent of the population living in poverty. While macroeconomic conditions remained broadly stable in the 1990s, growth was constrained by financial sector weaknesses, weak public sector management, poor governance, and low agricultural productivity. More recently, economic management has been complicated by security problems related to the Maoist insurgency and an uncertain political environment, with real GDP growth amounting to negative 0.5 percent in 2001/02.

However, there have been some modest improvements in 2002/03 made possible by the ceasefire, and GDP growth rose to more than 2 percent. The January 2003 ceasefire, however, broke down in August 2003 and peace talks stalled. If peace can be restored and structural reforms are implemented, growth is projected to rise further to 5-6 percent over the medium term. Similarly, the economy has witnessed price stability, with inflation expected to remain below 5 percent. While manufacturing and tourism are expected to be the main sources of growth, a significant contribution from agriculture is also envisaged. The current account deficit is projected to increase, but higher aid, remittances, and other inflows should allow international reserves to be maintained at six months of imports of goods and services.

Program Summary

The Nepalese authorities are seeking to break a vicious cycle of low growth, pervasive poverty, and insurgency. To this end, they intend to implement a comprehensive reform agenda outlined in their Poverty Reduction Strategy Paper (PRSP). The PRSP strategy is focused on broad based sustainable economic growth, social sector development, and targeted programs for the poor and disadvantaged people, and good governance.

The key elements of the Nepal's PRGF-supported program are in line with the PRSP:

On fiscal policy, the program aims at boosting revenue and reducing domestic financing, while redirecting spending to social and key infrastructure sectors. By 2005/06, revenue would be targeted to increase by 1 ¼ percentage points to 13 ½ percent of GDP, based on revenue administration reforms, increases in VAT rate, and rationalization of VAT and custom's exemptions. Reductions in domestic borrowing would help maintain fiscal sustainability.

The program's monetary and exchange rate policies, would remain geared to supporting the peg to the Indian rupee, which has served Nepal well given close ties with India. However, the level of the peg would be kept under review in light of prospective external developments, such as the phasing out of the Multi-Fibre Arrangement by 2005, which could pose challenges for export growth. Over the medium-term, competitiveness is to be enhanced by reforms to reduce labor and nonlabor input costs.

The strategy for the structural reform agenda focuses on financial and public sector reforms, and improving governance. Reforms in this area would create conditions for higher growth by improving intermediation and resource allocation, reducing corruption, and increasing accountability.

• Financial sector reforms involve central bank strengthening, improved legislation and loan recovery, and restructuring of commercial and development banks

• Public sector reforms include reforming the civil service to make it more efficient; privatization/liquidation of unviable enterprises and divestment from profitable ones to enhance their efficiency.

• Governance reforms involve steps to combat corruption and efforts to decentralize delivery of social services.