Press Release No. 10/74

Press Release: Statement of the IMF Staff at the Conclusion of the 2010 Article IV Discussions with Nepal

March 8, 2010

Ms. Laura Papi, Division Chief in the Asia and Pacific Department of the International Monetary Fund (IMF), issued the following statement today in Kathmandu:

“An IMF staff mission visited Kathmandu February 24-March 8, 2010, to conduct the 2010 Article IV Consultation discussions. The discussions focused on Nepal’s current economic situation, outlook, and macroeconomic policies.

“Macroeconomic stability has been maintained in past years, but the global crisis is having a delayed impact on Nepal’s economy and exposing its structural weaknesses. The exchange rate peg and prudent fiscal policies have been anchors of stability. High remittances have resulted in rising foreign exchange reserves despite lackluster export performance. Recently, however, international reserves have declined significantly due to a slowdown in remittances growth and accelerating imports partly as a result of continued rapid credit growth in the second quarter of 2009/10.  Lower reserves have been the main factor behind the squeeze in banks’ liquidity, which has exposed existing vulnerabilities in the financial sector. The liquidity crunch, in turn, has led to a sudden stop in credit disbursements after years of heady increases and much reduced transactions in the real estate market. While reserves have stabilized in recent weeks, the situation remains fragile.

“The macroeconomic outlook is challenging. After expanding by 4¾ percent in 2008/09, real GDP growth is expected to decelerate to 3 percent in 2009/10 due to a poor monsoon, softer remittances, and tighter monetary conditions. At the same time, inflation is projected at 11 percent by the end of the fiscal year. With weaker remittances and exports contracting, the current account is projected to shift into a deficit of about 2 percent of GDP. Risks to this outlook are on the downside, in particular if credit and import growth do not decelerate.

“Fiscal policy has remained prudent. The mission welcomes the government’s plan to reduce the domestically financed fiscal deficit for 2009/10 to 26 billion Nepalese rupees according to the authorities’ definition (equivalent to a net domestic financing of 1.6 percent of GDP). Revenue collection has been impressive in the past few years, but expenditure should be oriented more toward investment, which requires enhancing implementation capacity.

“The peg should remain the key macroeconomic policy priority, and monetary policy needs to be fully consistent with this objective. Interest rates need to be maintained above those prevailing in India and the Nepal Rastra Bank’s (NRB) liquidity management needs to be strengthened. When a general liquidity injection is not needed for the system, liquidity provision to sound individual banks with liquidity shortages should take place at penalty rates or at the bank rate under heightened supervision.

“Risks in the financial sector have been building up and need to be addressed urgently. Over the past years, accommodative monetary policy, weak supervision, and proliferation of financial institutions have led to rapidly rising asset prices and overextension of banks. Going forward, the financial system needs to adapt to an environment of slower growth and is likely to see deteriorating asset quality. The mission welcomes the NRB’s directives regarding prudential limits on credit-to-deposit ratios, real estate exposure, loan-to-value ratios, as well as the reintroduction of a minimum Statutory Liquidity Ratio. However, it is critical that these limits are enforced, and not diluted. In this respect, appointing a new governor who can provide strong and stable leadership for the NRB going forward is urgent. The authorities should also pass the revised Banking and Financial Institutions Act (BAFIA), encourage bank consolidation, refrain from issuing new licenses for the time being, and proceed with the restructuring of state-controlled banks.

“Tackling structural problems remains essential to achieve high growth over the medium term. While Nepal’s potential is high, progress is required in addressing the poor business climate, power shortages, infrastructure needs, weak governance, and difficult labor relations. Political stability and improved security are necessary conditions for progress in several of these areas.

“This mission conducted the regular Article IV Consultation discussions. Also, responding to the authorities’ request, the mission began discussions on a possible macroeconomic program that could be supported by IMF financial resources. The discussions are ongoing, and an IMF team could return to Kathmandu in the next few months to continue negotiations.”