January 2023 Analysis: Economy & Development

Posted by : Milan Acharya


Date : 2023-01-30

Nepal’s public debt has increased and in order to decrease the government's current expenses, the Ministry of Finance decided to cut the budget of the federal government. Frequent closures of borders at Tatopani and Rasuwagadhi have disrupted the Nepalese economy and the removal of cash margin provision during import will potentially lead to an increase in import activity and stimulate economic growth while declining the informal import inside the economy. Finally, in order to mop up the excess liquidity in the market, NRB issued a reserve repo after 18 months.

Timeline of Major Events

Date Events
19 January  Nepal Rastra Bank (NRB) removes previously imposed cash margin provision
20 January  Unofficially Rasuwagadhi border closed for 15 days
25 January  20 trillion 7 billion 13 million rupees comprise Nepal's public debt
26 January  Reverse Repo issued by NRB
31 January  20 percent budget cut for Federal Government

Macroeconomic Indicators

Nepal Rastra Banks (NRB)’s macroeconomic report for mid-January reveals a year-on-year inflation of 7.26 percent and an increase in inflow of remittance by 24.3 percent in NPR terms. Though, remittances help to stimulate the growth of small businesses and encourage entrepreneurship by reducing the limitations imposed by limited access to credit. There was a decrease in Nepal’s import by 20.7 percent and a decrease in exports by 32 percent in year-on-year basis. Decrease in imports is due to the import restrictions posed by NRB, the Balance of Payment (BoP) remained at surplus at Rs.97.10 billion. A decrease in both imports and exports generally indicates a slowing of trade activity, which can be a sign of a weaker economy leading to a decreased economic growth and potentially higher unemployment. Decrease in exports may also result in a decrease in foreign currency inflows, which can weaken its currency and increase the cost of imports.

Nepal’s public debt

According to the report released by the Ministry of Finance, in the first five months of the current fiscal year, Nepal's public debt (including both internal and external debt) has reached 20 trillion 7 billion 13 million rupees. The first five months of this fiscal year have seen a rise in foreign aid commitments of a whopping amount of 1 trillion 9 billion rupees; out of which, the share of debt is 80.24 percent while the share of grant aid commitments is 19.76 percent. The budget plan for this fiscal year has a total size of Rs 1.793 trillion. In order to manage such huge resources, the target of the government was to raise 2 trillion 26 billion in external debt and 2 trillion 56 billion rupees in domestic debt. However, till the end of November, the government has borrowed 29.57 billion in external debt and 17.5 billion in internal debt; which is an additional loan of 47 billion 7 million rupees than anticipated. Citing the financial pressure that Nepal is going through, the Ministry of Finance decided to cut the budget of the federal government by 20 percent. Large undertaking of loans for infrastructure development by the previous government has left the present government incurring high public debt.

High levels of public debt are detrimental to a country's economy. When a government owes a large amount of money, it must devote a significant portion of its budget to paying off that debt, which can limit its ability to spend on other programs and initiatives. Furthermore, high levels of debt can also increase the risk of a country defaulting on its debt which can have severe consequences not just for the country but also for the global economy. A budget cut of the federal government while the economy is going through a tough time is very welcoming, however, prioritising national pride projects which take longer duration to complete and ignoring the smaller projects which give results and return in a short period of time seems to be very unrealistic.

Frequent closure of Nepal’s northern borders

The border points between Nepal and China: Rasuwagadhi and Tatopani, have been known to close frequently due to various concerns raised by the Chinese government, one of them being China’s zero Covid policy. These closures have disrupted trade between the two countries and have significant impacts on the local economies. The Rasuwagadhi border which opened in late December will remain closed unofficially for 15 days starting from mid-January.

The frequent closures of border points between Nepal and China, significantly hamper Nepal's exports and further widen Nepal’s trade deficits. The closure of border points has been disrupting the flow of goods and services, characterised by delays in shipments, increased costs, and a decrease in the overall volume of trade. During the five months of 2022/23, merchandise exports to China decreased by 35.9 percent in the same period of the previous year. The trade deficit with China reached Rs 94.33 billion in the first five months of the current fiscal year.

In December, China ending its Zero-Covid Policy saw a rise in Covid cases in most provinces. China previously had attempted to ease its pandemic restrictions, only to tighten them when cases surged and this pattern seems to continue. With the borders, Tatopani and Rasuwagadhi partially open for imports and exports might again be halted if China goes back to Zero-Covid Policy. This leads to shortages of certain Chinese goods in Nepal, causing prices to rise, and affecting the purchasing power of consumers. Businesses that rely on the timely delivery of goods face a decline in sales and revenue. The disruptions in trade not only decrease the overall volume of trade but also result in a decrease in tax revenue from customs duties directly affecting the government's ability to fund public services and infrastructure projects.

The cash margin on imports removed after 14 months

The foreign exchange department of the NRB removed the imposed cash margin on imports by issuing a circular. Earlier, while implementing the margin deposit provision, the NRB had directed the business community to pay all types of imports through LC only, which was repealed last month. Now for small transactions and specified items, businessmen will be able to pay through Telex Transfers (TT) and other means (without opening LC). The NADA Automobiles Association of Nepal and the Nepal Chamber of Commerce (NCC) who were against the NRB’s cash margin provision now have welcomed NRB’s decision to remove such provisions.

The removal of cash margin provision during import will potentially lead to an increase in imports, as importers would no longer be required to hold cash reserves in banks as a buffer against potential fluctuations in currency exchange rates or other risks associated with imports. This could also potentially lead to increased competition and lower prices for consumers, as importers would have more capital available to invest in their businesses. However, it could also lead to increased financial risk for importers, as they would no longer have a buffer to protect them against potential losses. Small and medium businesses were hit hard due to such provisions as they were required to deposit large amounts of capital in cash. It is also important to note that the removal of the cash margin provision would not be a stand-alone policy change and its impact would depend on the overall economic and regulatory environment. This provision will also help to reduce the informal market as in order to avoid the costs and regulations associated with formal import procedures some importers might have chosen to bypass formal channels.

NRB issues Reverse Repo

Nepal Rastra Bank (NRB) issued a reverse repo (repurchase agreement) after 18 months indicating an end to the liquidity crisis in the market. The increase in the base rate of banks has lowered the demand for credits while it increased the cash deposits increasing the liquidity in the financial system. As the interbank rate fell below the deposit rate, which is the lower limit of the interest rate corridor, liquidity had to be drawn through reverse repo. When the interbank rate falls below the lower bound of the interest rate corridor set by the central bank, it signals a lack of demand for credit in the banking system. NRB’s half-yearly Monetary Policy Review is near and the central bank needs to raise its policy interest rate to increase the interbank rate as the central bank's goal is to maintain the interbank rate within the interest rate corridor to ensure stability in the financial system.