April 3: The consumer price inflation in Nepal is expected to remain high at 6.7 percent in 2024, close to the central bank's 6.5 percent ceiling, due to VAT exemptions removal, India's food export restrictions, and increase in minimum support prices of paddy, the World Bank said in its latest report.

However, inflation is forecast to decline to 6 percent in 2025 and 5.5 percent in 2026, driven by global commodity price moderation and domestic price containment through monetary policy, states the Nepal Development Update (April 2024) unveiled by the World Bank on Tuesday.

Projected lower inflation in India may also help reduce domestic inflation via the currency peg, mitigating imported inflation, the report added. According to the WB, Nepal's economic growth is set to rebound, from 1.9 percent in 2023 to a forecast 3.3 percent in 2024.

Growth is then projected to further accelerate to 5 percent on average, over 2025-2026. This recovery is largely attributed to the easing of monetary policy, assuming productive use of private sector credit. Additionally, reforms to improve business environment could attract more private investment, further boosting medium-term growth prospects.

The service sector is expected to be the key driver of growth in the coming years, according to the World Bank. Accommodation and food services are poised to benefit significantly from the rise in tourist arrivals.

The ongoing construction of new five-star hotels and government policies supporting real estate loans are expected to further stimulate the accommodation sub- sector, added the report. Meanwhile, the industrial sector is expected to grow, buoyed by significant expansions in electricity generation capacity, fostering a more conducive environment for industrial activities.

However, agricultural growth is projected to slow down due to various factors, including the outbreak of lumpy skin disease among livestock and a decrease in paddy production growth.

The current account balance is forecast to return to surplus in 2024, driven by robust remittance growth and a narrowing trade deficit, but is expected to narrow subsequently as remittances taper off and the trade deficit expands.

The trade deficit is expected to improve in the medium term, falling below its 2023 level. This is due to a projected decline in goods imports in 2024, although imports are expected to rebound in 2025 and 2026.

Goods exports, particularly in electricity, are expected to increase. While services exports could rise with tourism recovery, services imports may surpass exports due to continued emigration.

Despite efforts to attract more foreign direct investment, inflows are likely to remain modest. According to the World Bank, Nepal's fiscal deficit is poised to decrease significantly from its peak in 2023 (about 6 percent of GDP), stabilizing around 3 percent of GDP in the medium term, despite a projected higher deficit in 2024 compared to the government's revised forecast.

Revenue is expected to rise to 20.1 percent of GDP by 2026, supported by robust GDP growth and increased goods imports. Meanwhile, spending is expected to increase to 22.8 percent of GDP by 2026, driven by enhanced execution of public investment.

The National Project Bank’s integrated guidelines, introduced in March 2023, aim to streamline project development and prioritization, contributing to more effective capital spending by 2025, the World Bank added.

“Financing for the fiscal deficit will likely come from external concessional borrowing and domestic sources. However, public debt is projected to decline to 40.8 percent of GDP by 2026 from its 2023 peak because of higher economic growth.”

The forecast is subject to both domestic and external risks. Externally, geopolitical uncertainty could trigger a rise in commodity prices, impacting all sectors, the report further stated.

“A growth slowdown in partner countries might also lead to a drop in remittances and tourism, hindering economic growth. Persistent inflation expectations and lower domestic demand could further dampen economic activity. Natural disasters pose additional risks to sustaining welfare gains. Finally, frequent political changes, a top headwind for businesses for over a decade, could continue to deter private investment.”

The World Bank noted that Nepal's poverty rate fell due to migration and remittances, alongside consumption increases. The recent nationally household survey data from the Nepal Living Standard Survey 2022/23 shows a large decline in poverty from 25 percent to just 3.6 percent between 2011 and 2023 (using the 2011 National Poverty Line).

The prosperity gap and inequality also reduced over the same period. However, challenges persist with a weak labor market and limited social assistance, posing risks amid economic and climate shocks, it further stated.

On the fiscal front, the Nepal Development Update highlighted the need to strengthen the execution and efficiency of capital expenditure to boost economic growth, as well as the importance of reducing dependence on imports tax revenue. Sound and consistent monetary policy will also be key to boosting confidence and stimulating economic growth, the report added.

According to the World Bank, addressing the increasing level of non-performing loans in the financial sector is crucial to strengthen financial stability and support private investment.

On the external side, the high dependency on remittance inflows exposes the country to external shocks. Thus, there's a need to strengthen Nepal's international competitiveness for other sources of external earnings, such as tourism and foreign direct investment, by boosting exports of goods, the report suggested.