July 2022 Analysis: Economy and Development

Posted by : Aayushma Manandhar


Date : 2022-10-17

Timeline of Major Events

Year Event
July 15 Government extends its import ban on 10 luxurious goods by one and a half months.
July 17 Nepal Oil Corporation announces to pay Rs. 17 billion of its outstanding dues to Indian Oil Corporation.
July 22 Nepal Rastra Bank unveils the monetary policy for 2022/23.

New Monetary Policy

The previous fiscal year, to battle the economic slump induced by COVID, NRB had put forth a liberal monetary policy. Credit expansion and loosened requirements for banks, coupled with a post-pandemic economic boom, contributed to increased imports and a liquidity crunch in the banking sector. The new monetary policy, in line with what is being observed globally, is contractionary and aims to reel in the economy.

The main feature of the monetary policy is the contracted money supply growth and credit expansion. Credit expansion and money supply growth targets have been reduced to 12% and 12.6% respectively, from the previous figures of 18% and 19%. Since most of the credit expansion has been used to finance imports, this policy measure will reduce domestic demand, demand for imports, and thus relieve the trade deficit and forex reserve crunch. Likewise, policy interest rates have been raised by 1.5% each. Bank rate (the cost of borrowing from the central bank) and deposit rate (the rate of return on deposits) for instance have been increased to 8.5% and 5.5% respectively. This will push domestic banks to also raise interest rates, thus incentivizing reduced public spending and borrowing. The policy also features tighter liquidity requirements. Cash Reserve Ratio (the percentage of banks’ deposit required to be kept in the central bank in cash) and Statutory Liquidity Ratio (the percentage of deposits banks must maintain in liquid form) have been increased from 3% to 4% and 10% to 12% respectively. The policy has directed credit flow to the productive sector by allowing for distinguished interest rates for productive and non-productive sectors to ensure that despite limited credit expansion, economic growth is encouraged.

The proposed contractionary policy is appropriate at a time when the country is facing macroeconomic pressures such as inflation, growing trade deficit, and depleting forex reserves. While the monetary policy suggests a prompt rise in interest rates, the problem of liquidity crunch does not show an immediate sign of resolve. The proposed expansionary fiscal budget for 2022/23 also poses a challenge to the monetary policy, and the growth target of 8% is unlikely to be met.

Loss in Agricultural Production

The Department of Agriculture reported that by mid-July, just 54% of the country’s arable land had been cultivated for plantation, a 22% reduction from last year.

Agricultural production accounts for a quarter of Nepal’s GDP, but due to inadequate development in irrigation, the sector’s reliance on rainfall is evident each year. Although the monsoon began early this year, plantation was obstructed due to irregularity, especially in the Terai region. Reduced plantation is principally worrisome in Madhes province, where only 39% of paddy plantation was complete. While reduced plantation will certainly result in low production, even the land that is cultivated faces a shortage of chemical fertilizers.

With state-owned enterprises, Agriculture Input Company (AIC) and Salt Trading Corporation (STC) authorized to provide imported chemical fertilizers at subsidized prices to farmers, fertilizer shortages are perennial in Nepal. But global shortages and rise in prices has exacerbated the problem this year – fertilizer prices soared after the conflict in Ukraine and consequent sanctions on Russia disrupted supply. In February this year, Nepal signed a government-to-government deal with India, bypassing a long global tendering process. Accordingly, fertilizers were supposed to arrive in mid-July as crisis-mitigation but due to legal and institutional hurdles, the arrival remains uncertain. Further, despite the fiscal budget having increased the amount of money allocated for fertilizer subsidy from Rs. 12 to 15 billion, the sharp rise in prices renders this increase insufficient.

As a conjunction of reduced plantation and reduced productivity, agricultural production this year will doubtlessly be low. Apart from lowering the GDP, this is conducive to the country’s worsening trade balance in agriculture products.

External Sector

NRB’s macroeconomic report for June reveals a year-on-year inflation of 8.56%, a 70-month high. As a country that imports most essential and intermediate goods, with the largest import being petroleum products, Nepal’s inflation is primarily driven by external factors. On top of international rise in prices, the exchange rate of NPR with respect to USD has been on a steady increase, and it exceeded Rs. 128/USD this month. With imports becoming more expensive, the trade deficit increased by 25% in June compared to the previous month. While the foreign exchange reserve showed a growth, it still remains under pressure. Citing a lack of improvement in the reserve, the government announced to extend its 81-day ban of imports up to August 30.

Regardless, with the post-COVID resurgence of economic activity, there are signs of recovery. Remittance, for instance, is on an increasing trend – the number of migrant workers going abroad increased by over 400% in the eleven months of this year compared to last year whereas the number of renewed entries increased by over 200%. Likewise, the number of tourist arrivals has also increased, with 50,000 arrivals in June. Foreign direct investment commitments soared by up 68% year-on-year to Rs. 54.5 billion according to the Department of Industries.

Electricity export to India

India had allowed NEA to sell 364 MW of energy in its energy exchange market in April 2021. With surplus electricity generated during monsoon, Nepal has been exporting hydroelectricity to India.

The exported energy consists of surplus generated from Trishuli and Devighat Hydropower Projects, Kaligandaki Hydropower Project, Middle Marshyangdi, Marshyangdi, and Likhu-4, the first privately run plant to export hydroelectricity in South Asia. NEA reported a net earning of Rs. 1.72 billion in June by exporting 178.19 million units of electricity51. Meanwhile, NEA’s strategy to export electricity under a long-term Power Purchase Agreement (PPA) to India from July to November has been effectively scrapped. While the agreement would diversify risks for Nepali energy export, legal hurdles coupled by uncompetitive prices meant that trade through the Indian exchange is more beneficial. Thus, the possibility of export-promotion and import- substitution through a strong energy sector has emerged. However, since most hydropower projects in Nepal are run-of-the-river type, investments in reservoir-type projects are necessary to relieve trade-deficit problems in the long-run.

Nepal Oil Corporation and its Growing Debt

Having been granted a loan of Rs. 7 billion from the government and Rs. 3 billion from Rastriya Banijya Bank, Nepal Oil Corporation (NOC) announced to pay Rs. 17 billion of its outstanding debt of Rs. 30 billion to Indian Oil Corporation (IOC), and to not lower fuel prices until the debt is cleared.

With incessant rise in international fuel prices, NOC’s debt to its supplier, IOC, had been piling up despite periodic repayments. Its outstanding debt increased to over Rs. 30 billion in early July. Since the government levies taxes on petroleum products under various headings that amount to almost 50% of NOC’s buying price, the state-owned corporation had been calling for a reduction in taxes to relieve it from heavy losses and to curtail inflation in the country. Although the government announced a reduction in taxes, due to lack of coordination between the Ministry of Supplies and the Finance Ministry, the modalities of tax reduction are unclear. Moreover, with the extended import ban and policy targets to reduce imports, the importance of fuel taxes as a source of government revenue is paramount. As such, the perpetuity of tax reduction is unlikely.

Without tax reductions, NOC continues to incur heavy losses. Since the state-owned corporation plays the role of ensuring the supply of petroleum products in the country, its vulnerability to bankruptcy puts the entire country’s economy at risk. Moreover, the rise of fuel prices in the international market is expected to slow down because of worries for global recession. As such, NOC will be able to clear its debt soon, and fuel prices are likely to come down.