The Current State of Nepal’s Economy: Strengths and Strategic Shifts

Rameshwor Khanal, Finance Minister

A situation marked by excess liquidity and weak demand for investment in the productive sectors is not a desirable one. By nature, humans are inquisitive creatures who are never satisfied with what they have. Therefore, the public’s desire for a better economic growth rate and even higher employment growth is natural.

However, Nepal’s economic indicators are not as weak as some suggest. Our external indicators are very strong. We have observed an increase in the volume of raw materials imported by industries for production, which is a positive sign for economic development. Exports have also increased slightly, indicating a significant improvement in the external sector compared to two or three years ago.

Inflation is well under control. The average inflation rate has been around 2% since July, which is satisfactory. While we would ideally like to see higher credit flow, a growth rate of 8-9% should not be considered weak, especially when set against the prevailing narrative that the investment climate is poor. A crucial fact about this credit growth is that the bulk of the increase this time appears to have gone into the productive sector, whereas previously, a larger share went into the asset market. In my view, this is also a very positive indicator.

Fiscal Indicators and Capital Spending

On the side of public finance, the capital expenditure growth rate is lower than last year, a weakness primarily attributable to the impact of the floods and the Gen Z movement.

Conversely, revenue collection has increased surprisingly compared to last year. In October, collection exceeded the target compared to July and August. Cumulatively, customs revenue has grown by approximately 13%, Value Added Tax (VAT) by 10%, and Excise Duty by 13.84%. However, the decline in bank interest rates has caused income tax (on interest) to fall by 15%, and other corporate income tax by about 5%, resulting in a 7.6% overall decrease in income tax. The double-digit growth in VAT, Excise Duty, and Customs suggests an increase in both consumption and production, as Excise Duty is directly related to production.

Excise Duty on domestic production has risen by 14%, and on imports by 13.5%. The increase in Excise Duty on domestic production signals rising domestic output. Therefore, the estimates by international institutions that economic growth might contract this year may prove incorrect. It is unlikely to contract as they predicted; rather, the preliminary estimate is for growth of 4.2%, close to last year’s level, with some predicting 4.6%.

Last year, for the first time, the credit rating agency Fitch assigned Nepal a BB- rating. A BB- rating signifies a country suitable for risk-free investment. It means Nepal’s debt-paying capacity is maintained, but political instability is a concern. The same rating, with the same comment, has been maintained this year. Although political instability persists, the government’s overall fiscal position remains strong. The capacity to repay debt has not diminished. The rating was maintained because, despite a slightly weaker economic growth rate, all other factors were deemed stable.

Nepali experts have also considered these economic figures better than expected. Given the significant political instability caused by the Gen Z movement, market uncertainty, and the Supreme Court cases challenging the government’s legitimacy, the favorable economic indicators are noteworthy. This positive trend has been aided by policy reform decisions made over the past two months. With greater political stability, elections completed, and a stable government in place, we could achieve even greater improvements, as our economic data is not inherently weak.

Strategic Shift in Public Expenditure

Following the Gen Z movement, the government has further prioritized spending. Budgets allocated to small and unprepared projects have been postponed. The decision is rooted in the view that diverting funds from projects that do not offer immediate, long-term value in terms of economic or employment growth, and instead channeling that investment into large strategic projects, will be more beneficial for the nation. This government is implementing a philosophy of avoiding arbitrary spending of the state treasury without proper planning.

Conversely, the government’s perspective is that projects that are part of the Medium-Term Expenditure Framework and have already commenced work should be given resource assurance, as these will yield greater national benefit. Integrating these two policy concepts into future budgets will support national economic growth and help channel public investment into large strategic infrastructure projects that complement private sector investment.

Resource management has always been a challenge for the government. Currently, our focus is on settling all liabilities accrued in the past. Approximately $\text{NPR } 10$ billion in outstanding interest subsidies—promised to the banking sector for priority-sector lending and to the impoverished—has been paid. This payment will support small and medium businesses and expand the lending capacity of banks and financial institutions.

We are also preparing to reallocate funds saved from small, fragmented projects to settle outstanding payments for completed work in ministries like Physical Infrastructure, Energy, Irrigation, and Water Supply. Agreements for some of these payments have already been reached.

The Paradox of Liquidity

Currently, we have ample liquidity and low interest rates. In this situation, the government cannot borrow beyond its ceiling. We should be content if the government can finance its fiscal deficit at a low cost. However, this is not a good thing overall.

The government must ensure that its own investment projects are productive and do not compete with the private sector’s demand for investment. For example, while we can raise money through bonds at a 2% interest rate, the policy should be to take on debt at an 8% interest rate for a high-quality project, such as widening the Bhairahawa-Pokhara road. This expansion will boost economic activity and promote tourism, making it a major economic growth project. Borrowing at 8% for such a project is not expensive.

On the other hand, using 2% debt to simply pave a small road connecting two wards, or building a small four-lane road, will not contribute much to economic growth. It might be good for viewing or making TikTok videos, but it won’t impact economic or employment growth. Building roads to mines or hydropower projects, however, will directly contribute to economic growth. From this perspective, there is no reason to be overly pleased with the availability of cheap debt right now. Collectively, high liquidity coupled with weak demand for investment in the productive sector is not a good situation.

Alternative Financing and Reforms

If the government cannot borrow beyond its fiscal deficit limit, alternative institutions must be established. A proposal for alternative finance bodies was previously put forth but did not pass Parliament. The government now deems it very urgent and has registered the bill in the National Assembly. Even if passed there, it will require approval by the House of Representatives once the election is held. In the short term, since the government cannot act alone, we are preparing to explore arrangements where international financial institutions can raise such funds and create an environment for investment in productive sectors.

Regarding the cash subsidy on exports, while it was not included in the budget, the government’s commitment remains. The Ministry of Industry, Commerce, and Supplies is preparing the working procedure for the production-based subsidy. The Ministry of Finance has already urged the MoICS to pay the outstanding amounts from the available budget.

We are also working on good governance, anti-corruption measures, and simplifying service delivery across all ministries. The Ministry of Finance has developed an online system where taxpayers can now obtain a personal PAN number from their own local municipality while sitting at home.

An online valuation system has been introduced in customs, which has reduced the costs incurred by importers at the customs point, thereby lowering the overall cost of trade. This has also streamlined service delivery and improved governance by reducing the potential for undesirable transactions and tax evasion at various stages. This eliminates revenue loss for the government and makes it easier for honest traders to operate transparently—a means of establishing good governance and controlling corruption.

During this period, two agencies under the Prime Minister’s Office—the Department of Money Laundering Investigation and the Department of Revenue Investigation—have been brought under the Ministry of Finance. This decision was made because the departments were underperforming. Since being placed under the MoF, both bodies have accelerated their investigative work. Following the structural change, the Money Laundering Investigation Department alone has filed five or six cases involving billions of rupees in court. The Revenue Investigation Department is actively working to control revenue leakage.

The tradition of appointing individuals lacking the necessary skills and qualifications in tax administration to lead these departments has been abolished. New qualification standards, such as a background in economics or commerce to immediately handle income tax or customs-related work, are being set for new officers recruited through the Public Service Commission for revenue and customs.

Previously, tourists faced hassles due to the requirement to withdraw cash for visa fees, often leading to disputes at counters. An online payment system has now been introduced. We are implementing reforms to promote anti-corruption and good governance across all three tiers of government, including the Office of the Comptroller General, Customs, and Revenue. Taxpayer Service Offices have been abolished to reduce the potential for undue transactions.

Commitment to the Private Sector

It is essential to create awareness among citizens about the need to ensure the security of private sector investment, policy stability, and a pro-investment environment. The wealth and business created by the private sector are the sources of revenue, employment, economic growth, and prosperity. Therefore, the private sector should not be subjected to unwarranted attacks. While regulatory bodies must monitor and take action if they engage in wrongdoing, unnecessary hassle should not be given to businesses. A key government task is to raise awareness about fair judicial processes.

The government is firmly committed to protecting private sector businesses, a commitment we have repeatedly stressed. The government has always provided security when requested by the private sector. The incidents of September 8th and 9th were unexpected, which led to attacks on business establishments. We must consider this an exception and trust that the government is capable of providing security. We are reviewing what went wrong and are in the process of rectification. In this regard, the government and the private sector must move forward as partners, rather than blaming each other. The Ministry of Finance is actively taking the lead on this.

(This article by Finance Minister Rameshwor Khanal has been excerpted and translated in English from the ‘Sejan Smarika 2082’ of the ‘Society of Economic Journalists–Nepal’.)