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Current Macroeconomic

Development & Outlook


Chandan Sapkota
Asian Development Bank
Nepal Resident Mission

National Banking Institute, Kathmandu, 25 March 2015


The views expressed in this document are those of the author and do not necessarily reflect the
views and policies of the Asian Development Bank, or its Board of Governors, or the governments
they represent.

2015-03-25

Presentation Outline
Asian Economic Outlook

NEPAL: FY2014 Economic Performance

GDP growth
Inflation
External sector
Fiscal and monetary developments

NEPAL: FY2015 and FY2016 Economic Prospects


GDP growth
Inflation
External sector

Developing Financial Sector in Nepal


Policy Challenge: Accelerating Capital Spending
Largely based on Asian Development Outlook 2015

2015-03-25

Asian Economic Outlook

2015-03-25

Developing Asia Extends Steady Growth


GDP growth (%)
10
8

10-year average: 7.6


5-year average: 7.1

6
4

9.3
7.3

6.2

6.5

6.3

6.3

6.3

2012

2013

2014

2015f

2016f

2
0

2010

2011

f: forecast

Major Asian Economies Large contributors to


Global GDP Growth
Contributions to global GDP growth, 2015 (percentage points)

1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0

1.15
Global GDP growth: 3.5%

0.55
0.13

PRC

0.52

India

Indonesia

0.05

US

0.04

Japan Germany

Asia accounts for about 60% of global growth; still fastest-growing region
5

Key Growth Drivers for Asia


Reforms in DMCs
Recovery in
advanced economies
Reduction in
commodity prices

4.0

GDP growth (%)


2014
2015f
2016f

3.0

2.0
1.0
0.0

Moderation in PRC

US

Euro
area

Japan

f: forecast
6

Commodity Prices Tumbled


Commodity price indexes
2010=100

Futures

Brent crude

160
140
120
100
80
60
40

Food

Gold
Copper

Beverage
Natural gas

2010

2011

2012

2013

2014

2015

2016

Sources: World Bank Pinksheets; Bloomberg

Easing Inflation Pressures


Inflation (%)
8

6
5-year average: 4.3
10-year average: 4.1

4
6.0
2

4.4

4.1

3.8

3.1

2.6

3.0

2012

2013

2014

2015f

2016f

0
2010

2011

f: forecast

Lower Import Bills Widen CA Surplus


Current account (% of GDP)
15
PRC

10
5

Developing Asia
Japan

0
European Union

-5

US

-10

f: forecast
9

NEPAL: FY2014 Economic Performance

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10

FY2014 Overview

Growth accelerated to an estimated 5.2%


Inflation abated but remained high
Continued budget execution weakness
External situation strengthened
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GDP Growth (Basic Prices)


GDP growth accelerated to
5.2% in FY2014

Supply-side contributions to growth


Services

Industry

Agriculture

Percentage
points
6
5.2
4.6
4.3

Favorable monsoon
Agricultural growth at
4.7%

3.8
4

Strong remittance inflows


Services growth at 6.1%

3.5

Industrial output sluggish


Binding supply-side
constraints

2010

2011

2012

2013

2014

Note: Years are fiscal years ending on 15 July of that year.

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Inflation
Annual average inflation stayed
high at 9.1% in FY2014
Monthly inflation
% change
20

Overall

Food & beverage

Nonfood & services

Higher food prices offset gains


from falling prices of non-food
items

15

Food inflation averaged 11.6%


despite good agricultural harvest

10

Transport costs rose

0
Aug20 Feb20
10
11

Aug

Feb20
12

Aug

Feb20
13

Aug

Feb20
14

Aug

Jan

Supply-side bottlenecks
persisted
Food inflation worsened in India

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Current Account Balance


Current account surplus expanded
to 4.7% of GDP in FY2014

Current account indictors


Exports
Non-oil imports
Workers' remittances

Oil imports
Tourism and travel
Current account balance

% of GDP
40
30
20
10

Export growth 5.1%


Import growth 13.9%
Trade deficit 30.9% of GDP
Workers remittance growth
11.9%
28.2% of GDP ($5.5 bn)

BOP surplus surged to $1.3


billion

-10
-20
-30
-40
2010

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2011

2012

2013

2014

Forex reserves increased to


$6.9 billion
Covers 10.2 months of
imports of goods and
services

14

Fiscal and Monetary Developments


Fiscal indicators
Domestic revenue
Recurrent expenditure
Fiscal deficit or surplus

% of GDP
30

Commercial banks' weighted average rates

Grants
Capital expenditure

Nominal deposit rate


Nominal lending rate
Interbank rate

%
15

Real deposit rate


Real lending rate

10

20

10

0
0

-5
-10
2009

2010

2011

2012

2013

2014

2015

BE

Budget deficit: 0.1% of GDP


Actual expenditure: 82.4% of
allocation
Budget execution shortfalls
Long-standing procedural and
procurement inefficiencies

Robust revenue mobilization


Revenue including grants 21.3% of
GDP
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-10
Jul2012

Jan2013

Jul

Jan2014

Jul

Jan

Monetary conditions remained


accommodative
Interbank rate close to zero
Lending and deposit rates declined
Real deposit rate negative

Credit to private sector dropped


Monetary policy cannot compensate for
deficiencies caused by structural as well as
supply-side bottlenecks
15

FY2015 and FY2016 Economic Prospects

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FY2015 and FY2016 Overview


Economic outlook is less favorable than in FY2014
Encouraging news from power sector bolstered
business and investor confidence
Substantial moderation of inflation
External position expected to weaken

Downside risk of political instability


Unsettled constitutional and governance issues
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GDP Growth Outlook for FY2015 and FY2016


FY2015: 4.6%

FY2016: 5.1%

Unfavorable monsoon
Natural disasters (floods & landslides)
Political uncertainty
(Improved business confidence and
reform-oriented budget)

Normal monsoon
Timely full budget & effective budget
execution
High remittance inflows
Normalization of political uncertainties
Strong investor confidence

Supply-side contributions to growth (% pts)


5.2

4.6

5.1

4.6

4.3

3.5

0
FY2011

FY2012

Agriculture

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FY2013R

Industry

FY2014P

Services

FY2015f

FY2016f

GDP growth (basic prices)

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Inflation Outlook for FY2015 and FY2016


FY2015: 7.7%

FY2016: 7.3%

Expected agricultural shortfall and increase


in civil service salaries
Inflation forecast lower than central banks
target
Sharp drop in international oil prices
Multiple downward revisions to domestic
fuel prices
Lower inflation in India
Food inflation to remain relatively high
12
10

Inflation expected to edge lower


Better harvest
Broadly stable oil and commodity prices
Excess liquidity reined in

Contributions to inflation (% pts)


9.6

9.9

9.6

9.1
8.3

7.7

7.3

6
4
2
0
FY2010

FY2011

Food and beverage

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FY2012

FY2013

Non-food and services

FY2014

Nepal-CPI

FY2015f

FY2016f

India-CPI

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Current Account Outlook for FY2015 and FY2016


FY2015: 2.7% of GDP

FY2016: 3.5% of GDP

Stable export growth


Lower import growth

Substantially lower oil import bill

Slowdown in remittance inflows

6
5

Pick up in export growth


Continued lower fuel prices lowering
import bill growth
Strong remittance inflows
Strong tourism receipts

Current account balance (% of GDP)


5.0
4.7

3.5

3.4
2.7

3
2
1
0

FY2012

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FY2013

FY2014

FY2015f

FY2016f

20

Developing Financial Sector in Nepal

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Comparative State of Access to Finance


160
140

Outstanding deposits with commercial banks 2011


(% of GDP)

120
100

Outstanding loans from commercial banks in 2011


(% of GDP)

120
80

100
80

60

60

40

40
20

20

120
100

Account at a formal financial institution in 2011 (% age


15+)
OECD avg

70

Percent of firms with a bank loan/line of credit

60
OECD avg

80

50

60

40

40

30

South Asia avg


South Asia avg

20

20

10
0
Bhutan
(2009)

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Sri Lanka
(2011)

Nepal
(2013)

Bangldesh
(2013)

India
(2014)

Pakistan
(2007)

PRC
(2012)

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Status of Finance Sector

Total deposit: 73% of GDP


Total Credit: 68% of GDP

NPL (Share of total loan) declining; 2.9% in mid-July 2014


CAR: 12%
Stock market capitalization: 54.8% of GDP

Fairly stable finance sector compared the time when real estate and housing
prices collapsed.
Banking sector troubles surfaced prompting proactive role of the central bank

Persistent excess liquidity


Lack of investment-ready projects and favorable business environment
Rate of deposit mobilization > Rate of credit outflows
Declining lending and deposit rates

Ongoing consolidation of BFIs


Strengthened regulatory and supervisory capacities

Financial sector vulnerability persists


Bond market development at nascent stage

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Reducing Financial Sector Vulnerability


Liberal licensing regime led to too many BFIs and unhealthy
competition. Faster and effective consolidation is better.
Sound corporate governance
Continuous strengthening of NRBs monitoring, supervision
and regulatory capabilities
Cooperatives need to be better supervised and monitored.

Enhancing internal project and loan assessment

Operation efficiency and product/package innovation


Improvement in investment climate

Enhance productive sector lending

Important for an efficient financial sector that helps to generate high,


sustainable and inclusive economic growth

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Inflation
16
14
12
10
8
6
4
2
0

FY2013

FY2014

10

Y-o-Y non-food inflation

12
10
8
6
4
2

FY2013

FY2014

FY2015

FY2013

FY2014

Contributions to inflation (% pts)


9.6

9.9

9.6

9.1
8.3
7.7

7.3

6
4
2
0
FY2010

FY2011

Food and beverage

FY2012

FY2013

Non-food and services

FY2014

Nepal-CPI

FY2015f

India-CPI

FY2016f

FY2015

Jul

Jun

May

Apr

Mar

Feb

Jan

Dec

Nov

Oct

Sep

Aug

Jul

Jun

May

Apr

Mar

Feb

Jan

Dec

Nov

Oct

FY2015

12

14

Y-o-Y food inflation

Aug

Y-o-Y inflation

Sep

14
12
10
8
6
4
2
0

Deposit & Credit


40

Growth of deposits (% change)

Change in lending to construction and real


estate (NRs billion)

Growth of credit (% change)


30
30

30

25

20

20

20

15

10

10

10
5

0
FY2014
-10

Mid-year
FY2014

Mid-year
FY2015

Commerical banks

Development banks

Finance companies

Total deposit

0
FY2014

Mid-year
FY2014

Mid-year
FY2015

Commerical banks

Development banks

Finance companies

Total credit

-5

FY2007 FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 Mid-year Mid-year
FY2014 FY2015

-10
-15

Construction

Real estate

Interest Rates & Stock Market


Interbank and 91-day Treasury bill rate (%)
1.2
1.0
0.8
0.6
0.4
0.2
0.0

Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul

Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul

Interbank rate

91-day treasury bills rate


FY2015

FY2014

Weighted average rates of commercial banks

Mid-year stock market performance

14

1200

12

1000

10

800

8
600

400

200

0
Aug

Sep

Oct

Nov

Dec

FY2015 Deposit

Jan

Feb

Mar

Apr

May

FY2015 Lending

Jun

Jul

FY2012

FY2013

NEPSE index (closing)

FY2014

Mid-year
FY2014

Mid-year
FY2015

Market capitalization (NRs. billion)

Policy Challenge: Accelerating Capital Spending

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Inadequate and Weak Capital Spending


Budgeted and actual capital spending
Actual

% of GDP

Budgeted

Persistently weak capital


spending
Planned and actual spending
far below the required
investment in infrastructure
Actual spending < planned
spending

10

Insufficient capital
investment to bridge
infrastructure gap

0
2005

2006

2007

2008

2009

2010

2012

2013

2014

Raising quality and quantity of capital


spending is one of the pressing
challenges

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Spending on land, buildings,


furniture & fittings, civil works,
vehicles and plant &
machinery

29

Low Absorption Capacity


120

Actual spending (% of planned spending)

100
82.6
80
71.8

74.9

71.6

70.8

60

40

20

0
FY2009

FY2010

FY2012

Recurrent

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FY2013R

FY2014P

Capital

30

Bunching of Capital Spending


120

Monthly expenditure in FY2014 (NRs billion)

100

80

24.1

60
3.1
40
8.4

4.9

3.5
3.3

20

0.6

2.0

2.2

Nov

Dec

6.6

5.0

Apr

May

0.1
0
Aug-13

Sep

Oct

Recurrent

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Jan-14

Feb

Capital

Mar

Jun

Jul

Financing

31

Relatively Low Level of Investment


Fixed investment is
lower than LDC
average
Middle income
countries average
GFCF : 29% of GDP
Nepals GFCF
averaged 21.2% of
GDP over 2004-2013
Public : 3.8% of GDP
Private: 17.4% of
GDP

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2015-03-25
Innovation

Business
sophistication

Market size

Technological
readiness

Financial market
development

Minimum

Labor market
efficiency

Goods market
efficiency

Maximum

Higher education
and training

Health and prmary


education

Macroeconomic
environment

Infrastructure

Institutions

GCI 2014-2015

More competitive

Low Provision and Quality of Infrastructure


2014-2015 Global Competitiveness Index
Nepal score

33

Need for Higher Capital Investment


Suppressed economic growth requires a boost to aggregate demand
Initially, private investment continent upon public capital investment
Higher quantity and quality of capital investment
Boosts economic performance by accelerating recovery & establishing more
sustainable growth patterns
Generates aggregate demand quickly
Enhances productivity growth
Encourages technological innovation
Spurs private-sector investment by increasing returns

Higher quantity: Close the infrastructure deficit


Higher quality: Productivity-enhancing investment (infrastructure + human
capital)
Monetary policy: Relatively less effective
Fiscal policy: More effective; transmission mechanism direct and less
lags; Stabilization measures (short-term) & structural changes (long-term)
(Michael Spence. 20 Feb 2014. Why Public Investment?. Project Syndicate)

Why is Capital Spending low? - Inefficient Budget Execution


Bureaucratic hassles
Project approval
Inter and intra ministry coordination

Structural issues
Limited capacity of line ministries (planning & implementation)
Lack of strong pipeline of projects ready for implementation
Legislation hurdles (procurement & processes)

Low project readiness

Detailed design
Land acquisition
Project staff and offices
Procurement plans
Weak contractors capacity & construction management

Political instability
Poor quality at entry affects budget allocation efficiency as well
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What Needs to Be Done?


Improve quality at entry
Project readiness assessment
A standard framework needed (request, approval and monitoring)
Better inter and intra ministry coordination
Sector investment plans and human resources strategy

Address structural issues

Enhance planning & implementation capacities of implementing agencies


Project bank: Strong pipeline of key national infrastructure projects
Update relevant legislations to boost quality and quantity of spending
Prudent public finance management

Strengthen monitoring and evaluation


Standard monitoring framework
Incentives for better project performers

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Selected Economic Indicators (%)


FY2015 FY2016
GDP growth

4.6

5.1

Inflation

7.7

7.3

Current account balance (share of GDP)

2.7

3.5

THANK YOU!

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