February 2023 Analysis - Economy & Development

Posted by : Milan Acharya


Date : 2023-02-28

According to the mid-January macroeconomic reports published by Nepal Rastra Bank, the year-on-year inflation is limited to 7.26 percent, there is decreased exports and imports and an increase in remittance. The recent controversies surrounding Microfinance Institutions (MFIs) in Nepal have raised concerns about their lack of regulation and the possibility of profit-driven motives exploiting low-income individuals and groups. The long dry season has not only negatively impacted energy generation but will also decrease agricultural productivity. The recent protests by farmers in Chitwan have shed light on a significant issue in Nepal's agricultural industry, namely the unfair pricing of domestic products compared to exported products.

Timeline of Major Events

Date Events
3 February The farmers in Chitwan protested by throwing vegetables on the street.
17-18 February Nepal will now engage in real-time trading in the Indian electricity market
21 February China has suggested building a 220kV cross-border power line to import electricity from Nepal during the winter season.
22 February The central bank has increased its control over microfinance institutions
28 February The IMF staff and Nepalese authorities have come to a staff-level agreement regarding the policies required to finalize the ECF agreements.

Current Economic Situation

The macroeconomic report released by the Nepal Rastra Bank (NRB) for mid-January highlights some interesting trends in the Nepalese economy. According to the report, there has been year-on-year inflation limited to 7.26 percent and a significant increase in remittance inflow by 24.3 percent in NPR terms. Moreover, the report shows a decline in Nepal's imports by 20.7 percent and a decrease in exports by 32 percent yearly.

Despite the positive external indicators, an increase in remittance inflow and a depreciation of the US dollar by 1.79 percent in mid-January 2023 from mid-July 2022, which had appreciated by 0.95 percent in the same period of the previous year, there has been a slowdown in the industrial sector for the past few months. This has led to a decrease in both production and consumption capacity. Additionally, industrialists have been unable to take new loans due to the high-interest rate. While the liquidity situation has improved, the high-interest rates on debts have been halting the investment sectors.

The Nepalese government and the Central Bank had made significant policy efforts to control imports and tighten credit expansion, improving external indicators. However, risks remain as the global economy remains uncertain.

Despite the challenges, there have been positive developments in the Nepalese economy, such as an active tourism sector, and a steady increase in remittance inflow. Nepal's tourism industry saw an influx of 55,074 tourists in January 2023 and an even greater number of 73,255 visitors in February, according to data released by the Nepal Tourism Board. However, it is essential to note that risks remain, and continued policy efforts and investment in the economy will be necessary for sustained growth and development. 

Controversies surrounding Microfinance

Microfinance lending has been widely regarded as an effective tool for poverty alleviation in Nepal for decades. However, recent controversies have raised concerns about the exploitation of low-income individuals and groups and the lack of regulation and profit-driven motives of microfinance institutions (MFIs).

One of the most pressing issues facing microfinance lending in Nepal is the exorbitant interest rates charged by many MFIs.  Microfinances in Nepal are authorized to issue loans that don't require collateral, with a maximum limit of Rs 1.5 million. However, the interest rate that these institutions can charge on these loans is limited to 15 percent, with a condition to add 1.5 percent as a service charge but having charging more than that. This has resulted in borrowers struggling to repay their loans and falling into debt traps, leading to accusations of exploitation of the poor. Many borrowers are reportedly forced to sell their assets or take out additional loans to repay their microfinance loans, perpetuating a vicious cycle of debt and financial instability.
Furthermore, focusing on financial returns and profit maximization among MFI managers has contributed to controversies surrounding microfinance lending. Unhealthy competition among institutions to prioritize the quantity of loans over the quality of loans, leading to over-indebtedness and financial distress for borrowers are among the plaguing controversies. This over-emphasis on growth has also come at the expense of borrowers' well-being and financial stability.

These issues highlight the need for effective regulation and oversight of the microfinance sector in Nepal. The government and regulatory bodies must enforce the existing regulations to prevent the exploitation of low-income individuals and ensure that MFIs prioritize borrowers' well-being and financial stability over profits. Additionally, the microfinance sector should prioritize responsible lending practices, focusing on providing quality loans and supporting the sustainable development of borrowers. By doing so, microfinance lending can continue to be an effective tool for poverty alleviation in Nepal, benefitting both borrowers and the economy as a whole.

Extended Credit Facility from IMF

In January 2022, Nepal was granted a 38-month Extended Credit Facility (ECF) of $395.9 million by the IMF to help mitigate the effects of Covid-19 on the nation's health and economy. The funding was intended to safeguard vulnerable communities, maintain macroeconomic and financial stability, and promote long-term growth and poverty reduction. The IMF has stated that it will provide approximately $55 million in the second disbursement, but this had been postponed until February 2023 because Nepal had not fulfilled the necessary conditions.

During their trip to Kathmandu in February 2023, the IMF team led by Jarkko Turunen held talks with a range of stakeholders regarding the economic programme supported by the IMF's ECF. Following these discussions, a staff-level agreement was reached between the Nepali authorities and IMF staff on the policies and reforms required to complete the ECF. This agreement is awaiting approval from the IMF Executive Board, and if granted, approximately $52.2 million will be disbursed. With the approval from the IMF's executive board, Nepal will receive the remaining funds needed to disburse and effectively mitigate the effects of COVID-19 on the nation's health and economy.

The prolonged dry season, energy scarcity, and new hopes

The long dry season in Nepal has resulted in an imbalance in electricity production, import, and supply, leading to power cuts in the industrial sector. Due to the decrease in domestic production and the inability to produce electricity according to capacity, the country is experiencing a power shortage. Typically, even in winter, there would be sporadic rain. However, this year's prolonged dry season has significantly impacted Nepal's electricity generation capacity.

Nepal's reliance on India for electricity import has further exacerbated the situation. Nepal's hydropower projects' total installed capacity drops during winter, and only a limited quantity of electricity is imported from India. However, Nepal has recently been permitted to participate in real-time energy trade with India, an upgrade from the existing day-ahead market trade, which would benefit the country's energy trade giving Nepal a greater flexibility and control over their energy resources, leading to more efficient energy utilisation and potentially reducing energy costs. This can also promote better management of power supply and demand, which can have a positive impact on the country's economy and development goals.

Nepal is keen to open up power trade with countries such as China and Bangladesh. Still, currently, India is the only external market for Nepal to buy and sell electricity. However, no transmission line exists between Nepal and China. Nevertheless, Nepal’s proposal of exporting electricity to Bangladesh using India's transmission grid has been accepted positively. This move will give Nepal different options to earn foreign currency through energy trade.

The energy sector plays a critical role in Nepal's economic development. However, the country's reliance on hydropower, affected by the dry season, and the limited options for electricity trade with other countries pose significant challenges. Nepal must explore other energy sources, such as solar and wind power, and invest in transmission infrastructure to connect with other countries to ensure reliable and sustainable electricity supply for its industries and citizens.

Vegetables on roads

The recent incident in Chitwan, where farmers protested by throwing vegetables, highlights Nepal's dependence on importing agricultural products, despite being an agricultural country. Middlemen deprive farmers of the price they deserve, and consumers pay exorbitant prices due to their presence. The proximity of major vegetable production districts to major cities does not translate to affordable prices for consumers.

To address these issues, the government must take proactive steps, such as setting up collection centers, cold stores, and transportation services for locally produced foods. Promoting fewer harmful pesticides and chemicals can address food safety and health concerns. The government must also ensure timely access to essential chemical fertilizers and irrigation for farmers during dry seasons to improve agricultural yields and reduce dependence on imports.