Nepal: Risk Assessment
Country Risk Rating
Business Climate Rating
- Reliable remittance flows support consumption, the main driver of growth
- Expanding services sector, especially tourism
- Financial and technical support from India and China
- Recipient of vast sums of international aid
- Political transformation supports growing stability
- Landlocked, poor accessibility
- Natural disasters and extreme climate events, economy still affected by the 2015 earthquakes
- Infrastructure shortcomings, electricity and fuel shortages, undiversified export basket (clothing and agriculture)
- Tensions between China and India could make relations difficult
- Excessive dependence on the Indian economy, notably through a currency peg
- Governance shortcomings
Economic growth slows in the wake of COVID-19
Nepal's economic growth slowed sharply in 2020 and is not expected to return to pre-crisis levels in 2021. The COVID-19 pandemic spread rapidly across the country, resulting in a national lockdown lasting almost four months. The lockdown measures, the suspension of international and domestic flights as well as the closure of borders brought the country's economic activity to a standstill for a quarter, with an unprecedented impact on Nepalese growth.
Tourism (7% of GDP) was one of the sectors hardest hit by the health crisis. Lockdown measures, coupled with drastic travel restrictions, caused activity to slam to halt. This sector should gradually recover in 2021, thanks in particular to the reopening of borders. Construction slowed sharply due to lockdown measures and crisis-fuelled supply chain disruptions. However, it should accelerate in 2021 as the economy picks up. After a difficult year 2019, featuring a devastating monsoon and pest infestation, agriculture (about 25% of GDP and 70% of employment) saw yields decline in 2020 due to supply chain disruptions, which hampered access to fertilizers and delayed agricultural production. The sector should get back on track in 2021, as rice yields are expected to increase due to a favorable monsoon and the restoration of supply chains. Migrant workers' remittances (about 23% of GDP) also declined sharply, impacting the country's growth. As many families depend on these transfers, their consumption was negatively affected. In 2021, remittances should pick up due to an upturn in employment in Qatar and Malaysia, where the majority of expatriates work, which should stimulate consumption. After an estimated decline of 4% in 2020 due to the health crisis, public investment should recover in 2021. It may be harder to revive private investment because of the uncertainties related to the economic crisis and the reduction in capacity utilization.
The public deficit has increased because of the crisis
The current account deficit, which is traditionally very high due to the trade deficit (30% of GDP), shrank considerably in 2020, but is expected to widen again in 2021. In 2020, the decline in exports, which were heavily affected by the decline in tourism (which accounted for 30.8% of total exports in 2019), was more than offset by the decline in the price of imported oil, as well as a decline in imports linked to weaker domestic demand. In 2021, imports, particularly of consumer goods, are expected to recover, although at a moderate pace due to uncertainty, which will encourage households to save. Tourism is expected to recover at a slow pace. The deficit is financed in part by international financing, which has increased because of COVID-19, and by the central bank's foreign exchange reserves.
The public deficit widened in 2020 due to the increase in health expenditure to fight the pandemic and provide additional insurance for medical personnel. Social assistance was implemented to support the poorest and most vulnerable households. Loans were rescheduled over several months, and companies in the hardest hit sectors were allowed to apply for additional working capital loans. Nepal's central bank asked banks to step up lending to priority sectors. Partial compensation was introduced for workers in the formal sector in the event of job or wage loss, and support was implemented for informal sector workers who lost their jobs. These workers may participate in public works projects in return for a subsistence wage or receive 25% of the daily wage if they opt-out. The deficit is expected to reduce in 2021, but will remain significant.
Tensions within the communist government
Nepal is undergoing a significant transformation, marked by the transition to a federal structure of government. The Nepal Communist Party (NCP) led by Prime Minister Sharma Oli won the 2018 elections and has a majority in both houses. On December 20, the Prime Minister dissolved the Lower House following an emergency meeting of his government. Following this decision, he announced that legislative elections would be held early, on 30 April and 10 May. Protests broke out in the capital following the dissolution, underlining its unconstitutionality.
Geopolitically, the country is pursuing gradual realignment towards China and away from India. The country remains a disputed zone of influence between the region’s two giants: it is the third-largest recipient of Indian aid and is also part of the Chinese Belt and Road initiative. However, growing concern about mounting debt (external debt represented 17% of GDP in 2019), particularly towards China, could limit new construction projects.