Rising Remittances and Tourism Propel Nepal's Economy, But Debt Costs Loom

Nepal’s economy is experiencing steady growth, bolstered by tourism, remittances, and hydropower, yet faces fiscal challenges from rising debt costs and stagnating investment. Migration remains a critical economic driver, though high costs and social impacts call for better management and support for returning workers.

The World Bank’s recent Nepal Development Update offers a comprehensive examination of the country’s economic trajectory and challenges, focusing on migration’s impact on well-being. As Nepal’s economy rebounds, largely driven by sectors like tourism and agriculture, real GDP grew by 3.9% in FY24, following a modest 2% growth in FY23. A major driver was the surge in tourist arrivals, increasing by over 30%, which spurred activities in transportation, accommodation, and food services. Additionally, the World Bank notes that expanded hydropower production, adding over 450 MW, and a 4.3% rise in paddy production boosted economic growth. While private consumption, fueled by remittances, remains a key contributor accounting for over 80% of GDP investment and public expenditure has lagged. Austerity measures, low capital spending, and a drop in private investment due to reduced imports of intermediate and capital goods reflect a cautious approach to fiscal policy, resulting in low public investment levels and holding back growth in sectors reliant on infrastructural development.

First Current Account Surplus in Eight Years

The report highlights a critical shift, as Nepal registered a current account surplus for the first time in eight years. This surplus stems from high remittance inflows and a sharp decrease in imports. Remittances, reaching a nine-year high, were bolstered by record levels of migration. Meanwhile, merchandise imports fell significantly, with restrictions on rice exports and high tariffs on crude oil imports from India contributing to the decline. Nepal’s ability to export electricity at record levels to neighboring countries, along with growth in service exports due to tourism, helped drive this shift. Foreign reserves strengthened considerably, covering 13 months of imports by the end of FY24 a buffer that provides much-needed stability. However, the fiscal landscape remains challenging. Despite efforts to stabilize revenue collection, tax income has stagnated, marking a low not seen in eight years. Fiscal policy centered on austerity led to a reduction in recurrent spending, which included cuts to allowances, fuel, and office supplies. Although these measures succeeded in narrowing the fiscal deficit to a seven-year low of 2.6% of GDP, the reduction in spending reflects a concerning decline in budget execution efficiency, which has fallen below 80% for two consecutive years. Budget execution challenges are especially acute in capital expenditures, limiting the implementation of public investment projects and impacting economic productivity.

Rising Debt Costs and Inflation Moderation

While public debt remains sustainable, supported by concessional borrowing, the cost of debt servicing has risen to a record high, now exceeding capital expenditure. Rising interest rates and the redemption of domestic debt issued during tighter liquidity periods have escalated debt costs, marking a troubling fiscal trend. Meanwhile, inflation has moderated, averaging 5.4% in FY24, down from 7.7% in FY23. This decline is attributed to lower housing, utility, and transportation costs, reflecting falling fuel prices. Food inflation also eased slightly due to lower oil prices, though prices for essential staples remain elevated because of weather shocks and export restrictions on key items like rice from India. In the financial sector, the Nepal Rastra Bank’s cautious approach has aimed to support stability through lowered policy rates, which dropped to 5.5% by the end of FY24. This adjustment, along with liquidity absorption measures, has moderated short- and medium-term interest rates, increasing deposit rates to over 113% of GDP and driving higher real interest rates. Despite these gains, private sector credit remains stagnant, with limited lending growth particularly evident in household and business loans. In response, the central bank has introduced various measures to stimulate lending in targeted sectors, including real estate, where policies aim to increase lending limits and ease debt requirements.

Migration: A Lifeline with Challenges

The report’s special focus on migration underscores its importance to Nepal’s economy and welfare. In FY24, remittances constituted over one-fourth of Nepal’s GDP, driven by migration to Gulf Cooperation Council (GCC) countries and Malaysia, especially among young men facing high unemployment domestically. Migration has lifted many Nepali households, directly contributing to over 30% of poverty reduction between 2011 and 2023. Remittances enhance living standards and increase investments in health, education, and food security, with financial inflows benefiting households across the wealth spectrum. However, the high costs of migration, borne mainly by informal loans with high interest rates, limit the benefits, particularly for poorer families who cannot afford lucrative migration destinations. Moreover, the absence of migrants often places social and emotional strains on families left behind, affecting children’s educational outcomes and well-being. Migrants also face difficult conditions abroad, including long working hours, limited healthcare access, and exploitative recruitment practices. The report suggests that an effective and inclusive migration management system could enhance the benefits of migration while reducing its costs. This system would focus on improving pre-departure training, formalizing recruitment channels, and supporting returnees’ reintegration into the domestic labor market. Structured policies to ease migration costs, bilateral agreements to ensure migrant protection and incentives for returnees to invest their skills and capital domestically could make migration more sustainable.

Economic Growth Projections and Emerging Risks

Looking ahead, Nepal’s economic growth is projected to rise, driven by anticipated expansion in tourism, real estate, and construction. GDP is expected to increase by 5.1% in FY25 and by 5.5% in FY26, with sectors like retail and manufacturing poised to benefit from relaxed monetary policies. Despite these optimistic projections, the World Bank warns of several risks, including potential disruptions from regional instability, natural disasters, and internal financial vulnerabilities, such as rising non-performing loans that may curtail private sector credit. Political instability and frequent administrative changes could further deter investment and delay much-needed public infrastructure projects.

Recommendations for Sustainable Economic Resilience

The World Bank’s recommendations highlight the need for fiscal reforms, improvements in economic diversification, and better support for migrants and returnees as key steps to sustaining Nepal’s economic growth. These reforms, coupled with prudent fiscal management, could help Nepal strengthen its economic resilience, improve the effectiveness of migration as a development tool, and foster a more inclusive and stable domestic economy in the years to come.