Shielding Economy from External Shocks

The country’s economy was showing some signs of recovery after being severely plagued by the Covid-19 pandemic.But, unfortunately, it is again in the doldrums. The major reason behind this is the alarming deterioration of the external economic sector or the international economic transactions. The very sector of the economy refers to how good Nepal is in buying foreign goods and services with its key indicators being foreign exchange reserves, the balance of payment (BoP) situation, and the situation of international trade, among others.

 The performance of the very sector seems shockingly poor thanks to the   widening balance of payment (BoP) deficit, dwindling remittances, and   depleting foreign exchange reserves. “If there is no any tangible   improvement in such a performance, it could further wreck the already   fragile economy,” opines Keshav Acharya, a senior economist.  

  Worrying indicators of the external sector

 As of the third quarter of the current fiscal year, the country spent a hefty     Rs.1466.66 billion on imports, up 32.0 percent compared to the same   period last year. Besides imports, a huge sum of money worth Rs43.67   billion was also spent by Nepali students going abroad.

 On the other hand, the inflow of remittances decreased by 2.2 percent to   $6.05 billion during the first nine months of 2021/22.  Likewise, the total  earnings from exports, tourism and foreign direct investment are as low as Rs 196 billion only.

Because of all this, the foreign exchange reserves declined by $18.2 percent to $9.61 billion in mid-April 2022 from 11.75 billion in mid-July 2021, according to the NRB statistics.  As such, the available reserves can sustain the imports of goods and services for only 6.6 months against the central bank’s target of maintaining the reserves for imports for at least seven months.

With the volume of money going out of the country instead of coming in swelling greatly over the first three quarters, the BoP remained at a shocking deficit of 268.26 billion as of mid-April. The negative shocks of the aggravating external sector of the economy are also being felt in the domestic sector. For example, the inflation rate reached a 67-month high at 7.28 percent in mid-April. Similarly, the banking sector has been unable to finance the private sector enterprises due to a lack of loanable funds.

“Because of the growing international prices of commodities like energy, food items, and metals, the inflation rate in Nepal that is heavily import-oriented has  been moving up,” mentions Prakash Kumar Shrestha, Chief of Economic Research Department at the Nepal Rastra Bank.                   

The situation may further deteriorate

Economic indicators related to the external sector have moved down largely because of massive imports. The government and the central bank are taking “indirect” measures of import control from the second quarter of the current fiscal year.

For instance, in December last year, the central bank made it mandatory for importers to keep a 100 percent margin amount [guarantee given by importer to the bank] to open a letter of credit (LC) to import a number of goods.

Similarly, the government last April barred the entry of liquor and tobacco products (except their raw materials), diamonds, mobile sets priced over 600 U.S. dollars, color TV sets larger than 32 inches, and cars/jeeps among others.

But, unfortunately, such measures have failed to control the outflow of money for imports.  This is mainly because of the rising international prices of goods stemming from the Russia-Ukraine crisis. “The prime factor behind the rise in import bill despite the import control measures is the skyrocketing costs of imported goods,” concurs Shrestha.  “The prices of both petroleum products and food items have surged in the international markets after the Russia-Ukraine crisis.”

A World Bank (WB) report titled “Commodity Market Outlook” released on April 26 states the increase in energy prices over the past two years has been the largest since the 1973 oil crisis. Price increases for food commodities—of which Russia and Ukraine are large producers—and fertilizers, which rely on natural gas as a production input, have been the largest since 2008.

 “In fact, the global price rise of commodities is responsible for increasing Nepal's import bill by around 20 percent since the beginning of the current fiscal year 2021-22,” said Manik Lal Shrestha, former division head of the statistics division at the International Monetary Fund (IMF) at a programme in early May.

For example, the import bill of petroleum products almost doubled to Rs218.35 billion during the first nine months of the current fiscal year, according to central bank statistics.   The World Bank has warned that the rising prices could lead Nepal to a situation of higher inflation coupled with lower economic growth which is called stagflation.

“Higher commodity prices, recently spurred by the war in Ukraine, are expected to increase construction costs as well as consumer prices, dampening overall demand and in turn reducing economic growth by an estimated 0.2 and 0.6 percentage points in the fiscal year 2021-22 and fiscal 2022-23 as compared to previous projections,” said the World Bank in its recent report ‘ Nepal Development Update.

Not only the rising international prices (as a result of the Russia-Ukraine crisis) but the weakening domestic currency against the US dollar also fuelling the inflation.  “This has made imported goods by paying the US dollar expensive, making them unaffordable for the general public,” said Economist Acharya.

On the Road to Sri Lanka?

There are apprehensions that Nepal may also undergo an unprecedented crisis like Sri Lanka. In fact, such fears are not completely unfounded. It is because a massive dip in the foreign exchange reserves wrecked the Sri Lankan economy.  

Such reserves have plummeted by a mammoth 70 percent to USD 3.1 billion in two years. This is rendering the Island nation unable to even for essential imports, including fuel, leading to the debilitating daily power cuts lasting up to 13 hours. No wonder, ordinary citizens of this country are hit hard by the shortages and soaring inflation.  

Though Nepal is also facing a situation of depleting forex exchange reserves like Sri Lanka amid the rising cost of imports, officials and experts say that the former is still on the safe side.

 Though Nepal is also facing a situation of depleting forex exchange reserves like Sri Lanka amid the rising cost of imports, officials and experts say that the former is still on the safe side.  “The external economic sector of Sri Lanka went downhill because of its high indebtedness (with a compulsion to pay in high-interest rates), Covid-19-induced blow to the tourism and reduced production of grains,” said Shrestha of the NRB adding, “Nevertheless, the very sector of Nepal started to worsen due to high imports and reduced remittances.”  

A study carried out by the International Monetary Fund suggests that Nepal’s public debt scenario, in particular, is not as shocking as Sri Lanka’s.“The size of Nepal's public debt is 40.5 percent of the gross domestic product (GDP). But Sri Lanka's national debt is 111 percent of the GDP,” it points out.

Way Forward

  Despite the worrying indicators in the economy, all is not lost yet for     Nepal's economy. Shekhar Golchha, president of the Federation of     Nepalese Chambers of Commerce and Industry avers that Nepal's   situation is not as critical as it is being presented.  “In fact, Nepal’s   economy is already heading towards the direction of self-correction as the   demand for goods has come down along with the rising prices and liquidity   crunches in the banking sector which will decrease imports,” Golchha   added. 

 Obviously, there are limited sources of foreign exchange earnings with     remittance being the largest source of foreign exchange.  There are     indications of improvement in certain sources of foreign exchange.

  According to the statistics of the central bank, inflows of remittances have    increased lately though overall inflows over the first nine months of the    current fiscal year are negative. 

  In the month Chaitra  (mid-March-mid-April), Nepal received remittances amounting to Rs93.6 billion, which is the largest monthly inflow of remittances from mid-June to mid-July 2020, according to the central bank statistics. 

“Growing number of migrant workers this year is expected to help increase remittances in the future,” Manik Lal Shrestha, former IMF employee, said in a recent presentation on the state of the economy. According to the Department of Foreign Employment, the number of Nepalis going for foreign employment grew by 426 percent to 256,031 as of the first three-quarters of this fiscal.

Higher fuel prices may lead to stronger demand for migrant workers in the oil-exporting  Gulf countries, and consequently an increase in remittances

” Higher fuel prices may lead to stronger demand for migrant workers in the oil-exporting  Gulf countries, and consequently an increase in remittances,” the World Bank said in its report. 

Another positive outlook for the economy is that the number of tourists visiting Nepal has been growing in the last few months rapidly and tourism income is also on an upward trajectory. According to the Tourism Board, the number of foreign tourists visiting Nepal increased substantially reaching 137,095 in four months of 2022 which is close to the entire arrivals of 149,833 in 2021. Tourism earnings increased to Rs18.47 billion in the first nine months of this fiscal from Rs5.55 billion during the same period last fiscal year.

Golchha said that Nepal needs to develop more sources of foreign exchange, particularly foreign direct investment.  But immediate measures that Nepal should take, according to Manik Lal Shrestha, a former IMF official, is to expedite bilateral and multilateral funding for the projects in the budget and accelerate the process of approving FDI.

Experts said Nepal should also increase the sources of foreign exchange earnings as the country is heavily dependent.  Sri Lanka’s over-dependence on tourism for foreign exchange earnings and debt-fuelled infrastructure boom should serve as a lesson for Nepali policymakers, according to experts.

According to Shrestha of the central bank, two lessons to be drawn from Sri Lanka is that the country should not be overly dependent on one source of foreign exchange earning like Sri Lanka did on tourism and a country should not take foreign loans for unproductive projects by taking loans in commercial terms. “Nepal’s over-reliance on remittance is a risk for the long-term stability of Nepal’s economy. We have to diversify this risk,” said Shrestha.

Not only because of the dependence on remittances but Nepal’s very structure of the economy also makes the country vulnerable to external shocks, according to economists.  Nepal is heavily reliant on imports to meet the daily necessities of the people. “Considering the current situation of the external sector of the economy, there is an urgent need to reduce imports,” said Economist Nepal.