An IMF team assesses Nepal’s economy for Extended Credit Facility (ECF) extension

In the second-half of February 2023, a team of International Monetary Fund (IMF) led by Jarkko Turunen, Deputy Division Chief and Deputy Mission Chief for India in the Asia and Pacific Department (APD), visited Kathmandu for a staff-level discussion for the combined first and second reviews of the economic program supported by the IMF’s Extended Credit Facility (ECF).

During the meeting, IMF staff and the Nepal authorities reached a staff-level agreement on the policies needed to complete the combined first and second reviews of the ECF arrangement. 

Policies and reforms envisaged in the ECF-supported program, in particular, include:

1. formulating a comprehensive revenue mobilisation strategy, aimed at enhancing tax collection and making room for priority spending,
2. strengthening the management of fiscal risks, especially those arising from public enterprises, by developing systems for their prompt identification and monitoring,
3. improving efficiency and transparency of public investment spending,
4. continuing to advance reforms on banking regulations and supervision and ensuring bank asset quality, and
5. further strengthening NRB’s governance by amending the NRB Act in line with best international practices. 

Once the review is formally approved by the IMF’s Executive Board, Nepal would have access to about $52 million in financing, bringing total disbursements under the ECF thus far to around $156.6 million. Earlier in Jan 2022, the IMF had approved a 38-month ECF arrangement for Nepal equivalent to $375.8 million now (and equivalent to about $395.9 million at the time of approval).

The credit facility will be mobilised in mitigating the pandemic’s impact on health and economic activity, protect vulnerable groups, preserve macroeconomic and financial stability, and support sustained growth and poverty reduction. The availability of the credit facility is also expected to fill financing gaps and catalyse additional financing from Nepal’s development partners.

Earlier, the IMF provided emergency fund support to Nepal in May 2020 under the Rapid Credit Facility equivalent to $214 million at the time of approval.

What is the IMF?

A major UN financial agency, and an international financial institution, the IMF keeps a close tab on the international monetary system, monitors member countries’ economic and financial policies and makes provision of fund resources, technical assistance and financial services to countries in need. 

The IMF plays a central role in the management of balance of payments difficulties and international financial crises. Countries facing actual or potential balance-of-payments problems can borrow money — loans and concessional financial assistance — from the IMF where countries contribute funds to a pool through a quota system. 

What is IMF’s Extended Credit Facility (ECF)?

ECF is the fund’s major medium-term financial instrument for low-income countries (LICs) — that provides financial assistance to countries with protracted balance of payments problems, including in times of crisis. 

LICs can avail ECF on concessional terms, with no interest rates for a period of time, also applicable in the case of other IMF facilities such as the Standby Credit Facility (SCF) and the Rapid Credit Facility (RCF). The duration of ECF ranges from three to five years at maximum. 

Highlights of Jarkko Turunen’s assessment

In his concluding statement after the end of the mission, Turunen highlighted that Nepal has continued to make progress with the implementation of the ECF-supported program despite a challenging global and domestic environment last year, including the impact of Russia’s war in Ukraine and challenges of Covid-19 pandemic recovery.

Notable achievements include: 

• the external audit of the Nepal Rastra Bank with the assistance of international auditors – in line with international best practices, 
• publication of reports on both COVID-related spending and custom exemptions to enhance transparency, 
• drafting of amendments to bank asset classification regulations, and 
• strengthening bank supervision by launching the donor-supported Supervision Information System.

Turunen stated that the much-needed monetary policy tightening last year, together with the gradual unwinding of COVID support measures were decisive actions from the Nepali authorities to maintain a stable macroeconomic environment, which helped moderate credit growth and global commodity price shock induced inflation. 

“As a result, and in a context of resilient remittances, external pressures eased, and international reserves stabilised in the first half of FY 2022/23. The temporary import restrictions, mostly aimed at reducing the rapid post-pandemic growth of imports, were removed.” 

The slowdown in imports nevertheless dampened tax collections during the first half of FY 2022/2023, which has required expenditure rationalisation in the mid-year budget review to preserve fiscal discipline and debt sustainability, Turunen said in his statement. 

He further notes that bank asset quality has deteriorated, reflecting a decline in the repayment capacity of borrowers due to higher lending rates and rising leverage, a concern that is moderated by banks’ capital-adequacy ratios that are above the regulatory minima.

In line with the IMF’s earlier revision of Nepal’s growth rate from 6.1% to 4.2%, Turunen review suggests a similar growth rate — around 4.4% this fiscal year. “Real GDP growth is projected to soften to 4.4% — supported by the ongoing recovery of tourism, strong agriculture sector performance in the first half of the year and resilient remittances.”

Turunen further asserts that Nepal remains vulnerable to shocks, from volatile and higher global commodity prices and from natural disasters and weather variability. “Accordingly, cautious monetary policy remains appropriate to bring the still elevated inflation down towards the Nepal Rastra Bank’s (NRB) 7% target and to allow the economy to grow without placing undue pressure on international reserves”. 

Based on discussions with the government officials, he notes that the government further aims to address near-term fiscal pressure by rationalising expenditure with priority to high-quality infrastructure expenditure and social spending.

The preliminary findings of this mission led by Turunen will now lead to a report which will be subject to the IMF management approval, and will be presented to its Executive Board for discussion and decision.

Macroeconomic indicators improve but challenges remain
Earlier, the six month macroeconomic data released in January by the NRB showed that remittance inflow has jumped by 24.3% in Nepali currency and by 13.9% in US dollars. 

Remittance inflows reached Rs 585.08 billion in the first half of the ongoing fiscal year ending last mid-January, which had earlier decreased by 5% in the last fiscal year review period.

In US dollar terms, remittance inflows reached $4.50 billion this fiscal year which had declined by 5.7% last year.

Imports decreased by 20.7%, exports by 32%, and the trade deficit by 19.2%.

Balance of Payments (BOP) remained at a surplus of Rs 97.10 billion in the review period compared to a deficit of Rs 241.23 billion in the same period of the previous year.

In US dollar terms, the BOP remained at a surplus of Rs 734.4 million in the review period against a deficit of $2.02 billion in the same period of the previous year.

Gross foreign exchange reserves increased 10% to Rs 1337.29 billion in mid-January 2023 from Rs 1215.80 billion in mid-July 2022.

In US dollar terms, the reserves increased 8% to $10.30 billion in mid-Jan 2023 from $9.54 billion in mid-July 2022.

However, the government's low capital spending, impact of the months-long import ban on government coffers, high inflation, slump in consumption demand, and prevailing high interest rates which has diminished borrowers’ repayment capacity still pose challenges to Nepal’s economy.