NEPAL DEVELOPMENT UPDATE May 2016 Remittances at Risk NEPAL DEVELOPMENT UPDATE Remittances at Risk May 2016 Standard Disclaimer: This volume is a product of the staff of the The World Bank does not guarantee the accuracy International Bank for Reconstruction and of the data included in this work. The boundaries, Development/The World Bank. The findings, colors, denominations, and other information interpretations, and conclusions expressed in this shown on any map in this work do not imply any paper do not necessarily reflect the views of the judgment on the part of The World Bank Executive Directors of The World Bank or the concerning the legal status of any territory or the governments they represent. endorsement or acceptance of such boundaries Copyright Statement: The material in this publication is copyrighted. 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Photo Credits: David Waldorf (cover page, page i and 15) Laxmi Prasad Ngakhushi (page 1 and 13) Acknowledgements The Nepal Development Update is produced The team is grateful for collaboration and data twice-yearly with the following two main aims: to from various agencies and organization in Nepal. report on key economic developments over the In particular, we would like to thank Suman Raj preceding months, placing them in a longer term Aryal and Hem Raj Regmi (Central Bureau of and global perspective and to examine (in the Statistics), Pradeep Paudyal (Nepal Rastra Bank), Special Focus section) topics of particular policy Manika Manadhar (Nepal Oil Corporation), significance. The Update is intended for a wide Dinesh Bhattarai (Department of Agriculture), audience including policy-makers, business Nabin Pokhrel (Nepal Tourism Board), Kedar leaders, the community of analysts and Neupane and Gaurav Dhungel (Department professionals engaged in economic debates, and Immigration), Surya Sedai and Binod Acharya the general public. (Department of Customs), Prabhat Kumar (UNDP), and Jimmy Oostrum (UNICEF). This Update was produced by the World Bank Macroeconomics and Fiscal Management team for Cut-off date for data included in this report was Nepal consisting of Damir Cosic, Roshan May 30, 2016. Bajracharya, Sudyumna Dahal and Saurav Rana under guidance of Shubham Chaudhuri and Takuya Kamata. Sailesh Tiwari contributed to the Poverty Box. Dilip Ratha and Sonia Plaza, provided helpful guidance in preparation of the Special Focus. Rajib Upadhya and Trishna Thapa managed media relations and dissemination. Sunita Kumari Yadav ably managed the publication process. Table of contents EXECUTIVE SUMMARY .................................................................................................... i a. Outlook ............................................................................................................................................. ii b. Challenges ......................................................................................................................................... ii A. RECENT ECONOMIC DEVELOPMENTS .................................................................1 1. During 2015, and in the span of six-months, Nepal was hit by two major shocks .............. 1 2. These shocks have resulted in high inflation .............................................................................. 4 3. Suppression of trade has led to record foreign reserves ........................................................... 6 4. Growth in foreign reserves has been only partially sterilized translating to a rapid money supply growth .................................................................................................................................. 7 5. Trade disruptions severely affected government revenue collection as well as spending ... 8 6. In sum, FY2016 resulted in lowest growth in 14 years ........................................................... 10 B. OUTLOOK, RISKS AND CHALLENGES ................................................................... 13 C. SPECIAL FOCUS: REMITTANCES AT RISK ............................................................ 17 LIST OF FIGURES: Figure 1: April 2015 Earthquake and its many aftershocks ...................................................................... 1 Figure 2 Majority of the damage was concentrated in the housing sector ............................................ 1 Figure 3: Imports were reduced by two-thirds at the peak of disruptions ............................................. 2 Figure 4: While exports were reduced by half ............................................................................................. 2 Figure 5: Although imports have recovered, exports have not ................................................................ 3 Figure 6: Recovery in imports is primarily led by non-oil imports .......................................................... 3 Figure 7: Imports of petroleum products have normalized three months after the end of trade dis- ruptions ............................................................................................................................................. 3 Figure 8: Trade was re-routed away from the main logistical border crossing at Birgunj.................... 3 Figure 9: Tourist arrivals by air had already peaked in 2012 ..................................................................... 4 Figure 10: Earthquake had a higher impact on tourist arrivals by air then the trade disruptions ......... 4 Figure 11: Electricity usage by industrial and commercial entities contracted ......................................... 4 Figure 12: Supply disruptions have pushed inflation to a 7-year high ....................................................... 5 Figure 13: Leading to a widening gap with India’s inflation ....................................................................... 5 Figure 14: While differences in food prices with India have persisted, difference in non-food price has widened ...................................................................................................................................... 6 Figure 15: Leading to an appreciation of the real effective exchange rate ................................................ 6 Figure 16: Trade deficit improved markedly, however, the effect is dissipating with trade normaliza- tion .................................................................................................................................................... 6 Figure 17: Resulting in historic high foreign reserves .................................................................................. 7 Figure 18: Outflow of migrant workers has contracted since the earthquake ......................................... 7 Figure 19: Surplus current account has driven up Net Foreign Assets and money supply ................... 7 Figure 20: However, new bank loan issuance was contracting since the earthquake and recovered only after trade disruptions ended ................................................................................................ 7 Figure 21: Central bank’s interventions to contain money supply growth ............................................... 8 Figure 22: Despite sharp recovery of government revenue, shortfall is estimated to be significant .... 8 Figure 23: Nearly half of government revenues depend on trade.............................................................. 8 Figure 24: Expenditure has picked up ............................................................................................................ 8 Figure 25: Driven by recurrent while capital spending is below last year’s............................................... 9 Figure 26: As a result, bunching of capex likely to get worse in FY 16 .................................................... 9 Table of Contents (continued): Figure 27: Economic growth for FY2016 is at a 14-year low .................................................................. 10 Figure 28: And the growth slowed across all three sectors ....................................................................... 10 Figure 29: Comparison of poverty rates using different poverty lines.................................................... 11 Figure 30: Remittances have grown to more than 30 percent of GDP .................................................. 16 Figure 31: However, growth in remittances has coincided with decline in manufacturing sector ..... 16 Figure 32: Remittances represent by far the most important external inflow for Nepal ..................... 16 Figure 33: Remittances are a crucial component of current account, highest in South Asia, and a sig- nificant portion of reserves in Nepal ......................................................................................... 16 Figure 34: Growth in remittances has slowed down significantly since the peak in 2015 ................... 18 Figure 35: Outflow of migrant workers has continuously contracted since the earthquakes ............. 18 Figure 36: Significant drop in absolute number of registered migrant contracts in 2015 .................... 19 Figure 37: Driven largely by a slowdown in Malaysia ................................................................................ 19 Figure 38: GCC contribute largest share of remittances to Nepal .......................................................... 20 Figure 39: Correlation between GDP growth rate of GCC & Malaysia and inflow of remittances to Nepal............................................................................................................................................... 20 Figure 40: Without remittances current account would be in a significant deficit................................ 20 Figure 41: Trade taxes are highly dependent on imports which are fueled by remittances ................. 20 Figure 42: Recent slowdown in outward migration is larger than comparable one from 2009 .......... 21 Figure 43: Slowdown in migrant workers in FY09, followed by remittances slowdown in FY10 and FY11 had widespread impact on the economy........................................................................ 21 LIST OF TABLES: Table 1: Nepal Macroeconomic Outlook ................................................................................................ 14 LIST OF BOXES: Box 1: New World Bank global poverty line ........................................................................................ 11 Remittances at Risk Nepal Development Update Executive summary: Remittances at Risk During 2015, and in the span of six-months, Nepal as. Service sector was hit hard as tourism, trade, was hit by two major shocks. transport and bank lending were curtailed. Agricul- ture has been affected by lack of fertilizers and The first one was the April 2015 earthquakes that other inputs with production of rice, the largest caused a huge loss of life and assets. The second crop, reaching a seven-year low. Government rev- shock has come in the form of a near complete enues fell sharply, given Nepal’s large reliance on disruption of external trade following the adoption trade-related taxes, leading to a decline in public of the new Constitution. expenditures as well. Imports contracted for the first time in decades resulting in a sharply lower Nepal’s political parties intensified their efforts to trade deficit. Remittances continued to grow, albeit adopt a new constitution, after eight years of delib- at a slower pace, and together with the shrinking erations, spurred on by the shift in political priori- trade deficit have resulted high current account ties following the earthquakes. As the constitution- surplus and a record foreign reserves. al process drew to an unexpectedly rapid close, protests and clashes erupted in August 2015 across Reflecting both the earthquake and trade related the country’s southern belt bordering with India. disruptions, inflation spiked to over 12 percent (y/ Following the promulgation of the new constitu- y) by mid-January rising 5 percentage points in just tion on September 20, 2015, protests intensified. A four months from mid-September 2015. This was near-complete disruption in cross-border trade the highest inflation level since FY2009, with in- resulted in acute shortages of fuel and essential creases in food and non-food prices contributing supplies across the country, which in turn has cur- equally to the spike. As the trade disruptions end- tailed economic activity. ed, inflation has eased to back to single digits. With varying intensity, the trade disruptions— As a result, the overall growth rate for FY2016 is which lasted more than four months from Sep- estimated to be 0.6 percent (at market prices), the tember 2015 through January 2016—have affected lowest in 14 years. The impact of trade disruptions economic activity across the board. Industry came on economic activity has been nearly as large as to a near stand-still due to shortage of fuel and raw the impact of earthquakes as growth slowed 2.2 materials and its proximity to protest-affected are- percentage points from the previous year. Agricul- May 2016 THE WORLD BANK GROUP i Remittances at Risk Nepal Development Update ture and services experienced some of the lowest a fiscal deficit that is expected to narrow as recon- growth rates in recent history while industry con- struction efforts are completed. Similarly, current tracted for the first time in seven years. account will likely remain in surplus in the near term, but is expected to turn to deficit as remit- The trade disruptions have further affected pov- tances taper off and imports grow driven by the erty reduction efforts which were already ham- larger reconstruction efforts. pered by the earthquakes in 2015. Earlier estima- tions had suggested that the earthquakes could Challenges end up pushing an additional 0.7-1.0 million of Nepalis into poverty in FY2015 and FY2016. Pov- Normalizing fuel and other supplies to general pub- erty is expected to worsen as a result of trade dis- lic, along with effective mobilization of post- ruptions affecting the livelihoods of millions of earthquake reconstruction are key short-term chal- people across Nepal. Shortages of goods have lenges, particularly in light of fast-approaching mon- pushed up prices with inflation inching into dou- soon season. Additionally, the trade disruptions ble digit territory affecting welfare with significant have highlighted the need to urgently diversify the impact on the poor in Nepal, particularly in urban Nepalese economy, particularly in terms of trade, areas. Fuel related slowdown in economic activity transport options and supplies of key resources. together with the increase in transportation prices hurt casual wage workers that derive a bulk of External environment is likely to be less favorable their livelihoods from wages. Income from wages as well. With remittances comprising more than 30 accounts for anywhere between 30-50 percent of percent of GDP, Nepalese economy is extremely the total income of urban Nepalis who are poor or dependent on these flows. Oil-exporting Gulf Co- vulnerable to falling into poverty. operation Countries and Malaysia, which represent almost 97 percent of total Nepali migrants exclud- Outlook ing India, are a key source of remittances. As oil prices in particular, and commodity prices in gen- Following the two years of disappointing growth, eral, are likely to remain around their present levels activity is expected to rebound modestly. The re- during the forecast period, the possibility of a drop bound in growth in the forecast period is predicat- in remittances has increased. Given that remittanc- ed on stabilization of the political process and the es enable consumption-centric structure of the start of the earthquake rebuilding efforts. Howev- Nepalese economy and the government’s reliance er, growth from FY2018 is expected to moderate on taxation of imports as a major source of reve- in line with the country’s potential. Manufacturing nue, a sharp slowdown would have adverse effects in particular is expected to get some boost starting on growth, fiscal and external accounts, in addition from FY2017 with the apparels and garment in- to curtailing economic opportunities for Nepalis dustry getting a duty free access in the US market. abroad (see Special Focus of this update). The high inflation induced by the trade disrup- tions is expected to moderate towards the end of In the medium term, Nepal faces several simulta- FY2016, but likely to remain elevated owing to neous and daunting challenges ahead. From com- persistent supply-side bottlenecks during the fore- pletion of political transition and setting up of a cast period. new federal structure to challenges of successful leveraging of its endowments (hydropower poten- Fiscal and current account deficits are expected to tial, human capital) to achieve a faster growth, in- widen during the forecast period, as the recon- creasing poverty reduction and creating economic struction efforts take full shape. Government’s opportunities for its citizens at home. Regaining expenditure is expected to grow substantially after domestic and foreign investors’ confidence, partic- FY2016 owing to increase in earthquake-related ularly for hydropower development, is an added cash assistance as well as increased capital ex- challenge after series of shocks for a country that penditure. The revenues, however, are also ex- does not have a favorable track-record in mobiliz- pected to pick up, but at a slower pace, resulting in ing large-scale private investment. May 2016 THE WORLD BANK GROUP ii Remittances at Risk Nepal Development Update A. Recent Economic Developments 1. During 2015, and in the span of six-months, cording to the Post Disaster Needs Assessment Nepal was hit by two major shocks. (Figure 2). The earthquake not only caused physi- cal destruction, but it has put a dent on a stellar The first shock was the April 2015 earthquake record on poverty reduction. Simulations suggest and over 400 aftershocks that have caused a huge that the earthquakes could end up pushing an ad- loss of life and assets (Figure 1). Total damage is ditional 0.7-1.0 million of Nepalis into poverty estimated to be around USD 5 billion of which 60 during FY2015 and FY2016. percent is the damages in the housing sector ac- Figure 1: April 2015 earthquake and its many after- Figure 2: Majority of the damage was concentrated shocks in the housing sector Source: National Seismological Center via esri.com Source: Ministry of Home Affairs and UNDP May 2016 THE WORLD BANK GROUP 1 Remittances at Risk Nepal Development Update The second shock followed in September 2015 of demand met through formal imports at the peak in form of a near-complete disruption in cross of the disruption, petroleum products were hardest -border trade. Nepal’s political parties intensified hit. Consequently, prices of petrol in the black mar- their efforts to adopt a new constitution, after ket went up by 300-600 percent, while Liquid Pe- eight years of deliberations, spurred on by the shift troleum Gas (LPG) cylinders used for cooking and in political priorities following the earthquakes. As heating were not available in the market at the time. the constitutional process drew to an unexpectedly rapid close, protests and clashes erupted in August Following the end of the trade shock, imports 2015 across the country’s southern belt bordering have recovered quickly while exports have not. with India. Following the promulgation of the new Trade disruptions ended by the end-January 2016, constitution on September 20, 2015, protests in- and by mid-April, imports have recovered and tensified. A near-complete disruption in cross- have reached pre-disruption levels. However, ex- border trade resulted in acute shortages of fuel and ports are yet to recover (Figure 5). The recovery in essential supplies across the country, which in turn imports was primarily led by non-oil imports while has curtailed economic activity. While many in the formal imports of petroleum products are re- Nepal have accused India of barring shipments covering more slowly (Figure 6). The slow recov- from entering Nepal and imposing an ―unofficial ery in the imports of petroleum products is evident blockade,‖ India officially denied doing so, citing with difficulty of refilling of LPG cylinders by ―unrest, protests and demonstrations on the Nep- households, with an approximate wait of 1-2 alese side‖ as a cause of the trade disruptions. months for the refill even three months after the end of the trade disruptions. Normal supply of Trade disruptions sharply depressed both im- petroleum products at the pumping stations was ports and exports, but the petroleum products established only by mid-March, two months after have been hardest hit. Trade disruptions lasted the end of the trade disruptions (Figure 7). almost five months—from mid-September 2015 until end-January 2016. At the peak of the disrup- The main border crossing for foreign trade, tion in mid-November, exports were reduced by Birjung, is yet to recover following the end of half while imports were reduced by two thirds trade disruption India is Nepal’s largest trading compared to their pre-disruption levels (Figure 3, partner, accounting for 65 percent of Nepal’s total Figure 4). Imports recorded a contraction for the trade, and the principal transit route as more than first time in decades. With only about 20 percent 85 percent of all imports enter through India irre- Figure 3: Imports were reduced by two-thirds at Figure 4: While exports were reduced by half… the peak of disruptions (in million USD) (in million USD) Oil imports Non-oil imports Total Exports 900 120 800 100 700 600 80 500 60 400 300 40 200 20 100 0 0 Oct Oct Oct Oct Oct Oct Oct Oct Oct Oct Dec Feb Apr Dec Feb Apr Dec Feb Apr Dec Feb Apr Dec Feb Apr Dec Feb Apr Dec Feb Apr Dec Feb Apr Dec Feb Apr Dec Feb Apr Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Jun Jun Jun Jun Jun Jun Jun Jun FY12 FY13 FY14 FY15 FY16 FY12 FY13 FY14 FY15 FY16 Source: Nepal Rastra Bank (NRB) Source: NRB May 2016 THE WORLD BANK GROUP 2 Remittances at Risk Nepal Development Update Figure 5: Although imports have recovered, exports Figure 6: Recovery in imports are primarily led by have not non-oil imports (percent change, 3-month moving average, yly) (percent change, 3-month moving average, yly) 40 Exports Imports 60 Oil imports Non-oil imports 30 40 20 20 10 0 0 -10 -20 -20 -40 -30 -60 -40 -50 -80 -60 -100 Aug Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Aug Oct Dec Feb Apr Aug Oct Dec Feb Apr Jun Jun Aug Feb Apr Aug Feb Apr Aug Feb Apr Aug Feb Apr Oct Dec Oct Dec Oct Dec Oct Dec Jun Jun Jun FY12 FY13 FY14 FY15 FY16 FY13 FY14 FY15 FY16 Source: NRB and WB staff calculations Source: NRB and WB staff calculations Figure 7: Imports of petroleum products have nor- Figure 8: Trade was re-routed away from the main malized three months following the end of trade logistical border crossing at Birgunj disruptions. (Petrol, diesel, air fuel in thousand kiloliters; LPG in thousand metric tons) (percent, share of total customs revenue) 120 Petrol Diesel LPG Air Turbine Fuel FY 15 (9 months) FY 16 (9 months) 45 100 40 35 80 30 60 25 20 40 15 20 10 5 0 Feb May Aug Sep Oct Nov Apr Aug Sep Nov Feb Dec Jul Dec Apr Jan Oct Jan 0 Mar Mar Jun Birgunj Dry Port Bhairawa Biratnagar Tribhuwan Others FY15 FY16 Airport Source: NOC and WB staff calculations Source: NRB and WB staff calculations spective of their country of origin. Out of this this, Contraction in tourist arrivals is estimated to about 40 percent of trade is carried out through be highest in 13 years. Tourist arrivals to Nepal Birjung which came to standstill and was a focal have peaked in 2012 with growth stagnating for point of trade disruptions. Consequently, trade was the last few years. The two shocks of 2015 have re-routed away from the main logistical border hit the industry hard. Preliminary estimates show crossing at Birgunj which is yet to recover the dis- that 2015 will post an 8 percent contraction of ruptions, while trade going through other border tourist arrivals via air, a largest contraction in 13 points has increased significantly (Figure 8). years (Figure 9) with the earthquake having a much larger effect on air arrivals than the trade May 2016 THE WORLD BANK GROUP 3 Remittances at Risk Nepal Development Update disruptions (Figure 10). However, receipts from Industrial and commercial activity slowed tourist arrivals are likely to contract even more as sharply as well. Manufacturing, which was mostly popular mountain climbing destinations were unaffected by the earthquake, has been severely hit closed in the aftermath of the earthquake while due to its close proximity to protests that have hotels and restaurants curtailed their offerings dur- halted transport and availability of raw materials. ing the trade disruptions. While data for arrivals At the peak of trade disruptions during October via land is not yet available, it will likely show a and November, reports indicated that the sector negative contribution to the sector as well given was operating at minimal capacity. As a proxy for scarcity of petroleum products. activity, the electricity usage by industry contracted by 31 percent (y/y) at the peak of disruption in mid-December (Figure 11). The woes by manufac- Figure 9: Tourist arrivals by air had already peaked turing were further compounded by lack of diesel in 2012 need for running of back-up generators. However, use of electricity by household surged, posting a (in thousands) growth of 16 percent in mid-December (y/y), as households switched to electricity for cooking giv- Tourist arrival - air Tourist arrival - land 700 en the unavailability of LPG. 600 2. These shocks have resulted in high inflation. 500 Both earthquake and trade disruptions have 400 contributed to higher inflation. Although infla- tion had been moderating during FY2015, it spiked 300 to over 12 percent (y/y) by mid-January 2016 rising 4.9 percentage points in just four months from mid- 200 September 2015. This was the highest inflation level 100 recorded since FY2009, reflecting both earthquake and trade related disruptions. Increases in food and 0 2001 2003 2005 2007 2009 2011 2013 2015 non-food prices contributed equally to the spike in inflation. Inflation eased to 9.7 percent (y/y) in mid- Source: Ministry of Tourism and Department of Immigration April, as the trade disruptions ended (Figure 12). Figure 10: Earthquake had higher impact on tourist Figure 11: Electricity usage by industrial and com- arrivals by air then the trade disruptions mercial entities contracted (in thousands, 3 month moving average) (percent change, y/y) Tourist arrival (air) Total Domestic Non commercial Commercial Industrial 90 20 80 70 10 60 0 50 -10 40 30 -20 20 -30 10 0 -40 Feb Mar Apr May Sep Nov Dec Feb Mar Apr May Aug Oct Aug Sep Oct Nov Mar Dec Feb Apr May Aug Sep Nov Dec Jan Jun Jul Jan Jun Jul Jun Jul Oct Jan Aug Sep Oct Nov Dec Jan 2013 2014 2015 FY 16 Source: Ministry of Tourism and Department of Immigration Source: Nepal Electricity Authority May 2016 THE WORLD BANK GROUP 4 Remittances at Risk Nepal Development Update Food inflation more than doubled during the price, input costs in the transportation sector rose first six months of the FY2016. It rose from 7.2 and was passed on to the end consumer leading to percent (y/y) in mid-August to 15.2 percent (y/y) a spike in transportation inflation. in mid-January adversely affecting the purchasing power of consumers. Cereal grains inflation, which Spike in inflation in Nepal has led to higher had been remaining stubbornly high on average divergence of inflation with India. Given the owing to persistent supply bottlenecks within Ne- pegged exchange rate, inflation in Nepal is influ- pal, ticked up once again even as cereal prices in enced by prices in India and generally follows the India continued to decelerate. Imported foods like evolution of inflation in India with a lag. However, cooking oil experienced extreme price increase inflation in Nepal has been increasingly diverging from 6.4 percent (mid-August) to peak at 42.4 per- from that of India’s for the past eighteen months cent in mid-December. Shortage of sugar at the driven primarily by food prices in Nepal. By mid- onset of the annual festival season, when demand February 2016, the gap in headline inflation was at for sugar products from confectionaries is the peak with 6 percentage points (Figure 13). In addi- highest, saw an increase in prices from -0.5 per- tion, since the beginning of FY2016, non-food pric- cent (y/y) in mid-August to 7.5 percent (y/y) in es in Nepal have also started to diverge from non- mid-December. food prices in India with a significant gap opening up by February 2016—up from almost no gap in Non-food prices had been moderating over June 2015 to a gap of 5.1 percentage points by mid- FY2015 but began experiencing upward pres- February (Figure 14). This has led to a depreciation sure after the earthquake. They shot up from of the real effective exchange rate by 14 percent, 6.6 percent in mid-August to 10.1 percent in mid- from the average level in FY2014 (Figure 15). February. The trade shock also compounded the pressure on prices as goods stuck at the border 3. Suppression of trade has led to record for- created shortages in Nepal and as importers used eign reserves. alternative means of importing through other bor- der points or by air. Similarly, the transportation As the trade disruptions normalize, the im- sector was also hit as fuel imports dried up, precip- provements in trade deficit are dissipating. As itating the emergence of a black-market. As black- imports are nine times larger than exports, and market diesel and petrol were available at premi- given that trade disruptions have affected imports ums of 300 percent to 600 percent over pump more than exports, the trade deficit narrowed Figure 12: Supply disruptions have pushed inflation Figure 13: Leading to a widening gap with India’s to a 7-year high inflation (Contribution to headline inflation, percentage points, y/y) (percent change, y/y) Food and Beverage Non-food and Services Overall 14 Nepal Inflation India Inflation 14 12 12 10 10 8 8 6 6 4 4 2 2 0 0 Mar Mar May May May May Sep Nov Mar Sep Nov Mar Sep Nov Mar Sep Nov Jan Jul Jan Jul Jan Jul Jan Jul Jan Feb Feb Aug Oct Dec Apr Aug Oct Dec Feb Apr Aug Feb Dec Apr Apr Apr Oct Aug Feb Oct Dec Aug Oct Dec Jun Jun Jun Jun FY12 FY13 FY14 FY15 FY16 FY12 FY13 2014 FY15 FY16 Source: NRB and WB staff calculations Source: NRB, CSO India and WB staff calculations May 2016 THE WORLD BANK GROUP 5 Remittances at Risk Nepal Development Update sharply during FY2016. The trade deficit in the April/May earthquakes (Figure 16). The cumula- first nine months of FY2016 is down 14.6 percent tive effect of the trade balance improvement and (in dollar terms) compared to the same period of growing remittances has put the current account at FY2015, however, this effect is fast dissipating a comfortable surplus of USD 1.3 billion for first going forward as the trade normalizes, in particular nine months into FY2016. This has also led to a as imports have rebounded faster than exports. At historic in Nepal’s foreign reserves with over USD the same time, remittance continued to expand, 9 billion being accumulated by mid-April 2016, albeit at a slower pace, following a surge in remit- covering 15 months of merchandise and services tances during the last quarter of FY2015 after the imports (Figure 17). Decline in outflow of migrant works has per- Figure 14: While differences in food prices with sisted since the earthquake. Following the April India have persisted, difference in non-food price earthquakes, outflows of migrant workers has de- has widened clined consecutively for ten months. By mid-April (percentage points) they have contracted by 25 percent (y/y) (Figure 18). Two factors are affecting this trend: (i) in the Food & Beverage Differential Non-Food Differential 10 aftermath of the earthquakes potential migrants are increasingly choosing to stay at home to support 8 their families with rebuilding homes and liveli- 6 hoods, and (ii) a weaker demand for worker from 4 commodity exporting host countries where low 2 commodity prices have dented their incomes and weakened their fiscal balances. 0 -2 4. Growth in foreign reserves has been only -4 partially sterilized translating to a rapid money supply growth. -6 May Mar May Mar May Sep Mar Sep Mar May Mar Jan Jul Sep Nov Jul Nov Jul Nov Jul Sep Nov Jan Jan Jan Jan The surplus current account has increased foreign FY12 FY13 2014 FY15 FY16 reserves of the central bank (Nepal Rastra Bank, Source: NRB, CSO India and WB staff calculations NRB) and fed the increase in net foreign assets Figure 15: Leading to an appreciation of the real Figure 16: Trade deficit improved markedly, how- effective exchange rate ever, the effect is dissipating with trade normaliza- tion (index number, 2010=100) (USD millions, 3-month moving average) 115 Nominal Effective Exchange Rate Real Effective Exchange Rate Current Account Trade deficit Remittances 700 110 600 500 105 400 100 300 95 200 90 100 0 85 -100 80 Feb Apr Apr Apr Apr Aug Oct Aug Oct Feb Aug Feb Aug Feb Aug Feb Apr Dec Jun Dec Jun Oct Dec Jun Oct Dec Jun Oct Dec -200 Aug Oct Dec Feb Apr Aug Oct Dec Feb Apr Aug Oct Dec Feb Apr Aug Oct Dec Feb Apr Aug Oct Dec Feb Apr Jun Jun Jun Jun FY12 FY13 FY14 FY15 FY16 FY12 FY13 FY14 FY15 FY16 Source: WB staff calculations Source: NRB May 2016 THE WORLD BANK GROUP 6 Remittances at Risk Nepal Development Update which has been growing steadily since the last quar- partially sterilized. The liquidity in the system did ter of FY2015 (Figure 19). The upward pressure on not translate into new credit given general uncer- money supply has led to NRB revising its money tainty amid trade disruptions. New credit issuance supply growth target FY2016 to 21.5 percent during growth has been contracting on y/y basis since its mid-year review from an initial expected growth June 2015 and has rebounded strongly following rate of 18 percent at the beginning of FY2016. the end of trade disruptions at the end-January However, even this revised target has not been met (Figure 20). During this period, NRB tried to con- as broad money supply grew by 25 percent (y/y) in tain excess liquidity in the system by conducting mid-April as inflow of foreign reserves was only multiple rounds of reverse repos, totaling NPR Figure 17: Resulting in historic high foreign re- Figure 18: Outflow of migrant workers has con- serves tracted since the earthquake (LHS: USD billion; RHS: months) (LHS: in thousands, 3-month moving average, RHS: percent change, y/y) Migrant Workers Outflow Growth rate (right axis) Total Reserves Import Coverage (right) 80 80 12 20 60 60 9 15 40 40 20 20 6 10 0 0 -20 -20 3 5 -40 -40 0 0 -60 -60 May Feb May May Feb May Aug Nov Feb Aug Nov Aug Nov Feb Aug Nov Aug Nov Feb May Nov Feb May Nov Feb Nov Feb May Nov Feb May Aug Aug Aug Aug Aug Nov Feb FY12 FY13 FY14 FY15 FY16 FY12 FY13 FY14 FY15 FY16 Source: NRB Source: NRB Figure 19 :Surplus current account has driven up Figure 20: However, new bank loan issuance was Net Foreign Assets and money supply contracting since the earthquake and recovered only after trade disruptions ended (contribution to M2 growth, percentage points, yly) (LHS: NPR billion, 3-month moving average; RHS: percent change, y/y) 40 Net Foreign Assets Net Domestic Assets Broad Money (M2) Agriculture Industry Service Others Total credit growth (right) 50 250 35 30 40 200 25 30 150 20 20 100 15 10 50 10 0 0 5 0 -10 -50 Mar May Mar May Mar Nov Jul Sep Nov Jul Sep Nov Jan Jan Jan Aug Oct Feb Feb Feb Dec Apr Aug Oct Dec Apr Aug Oct Dec Apr Feb Apr Feb Apr Jun Jun Jun Aug Oct Dec Jun Aug Oct Dec FY12 FY13 FY14 FY15 FY16 FY14 FY15 FY16 Source: NRB Source: NRB May 2016 THE WORLD BANK GROUP 7 Remittances at Risk Nepal Development Update 165 billion, as well as multiple deposit auctions result of the trade disruptions, given Nepal’s large amounting to NPR 297 billion, at very low interest reliance on trade-related taxes. Almost half of total rates (Figure 21). revenue come from trade related taxes (Figure 23). Revenues have picked up significantly by mid-April 5. Trade disruptions severely affected govern- 2016 as they registered a sharp recovery following ment revenue collection as well as spending. the end of trade disruptions which is likely to have bolstered by large one off tax collection (Figure 22). Despite the recovery of government revenue, Nonetheless, revenue shortfall (actual collection the shortfall in tax revenue is estimated to be compared to plan) is estimated to be about USD150 significant . Government revenues fell sharply as a million (about NPR15 billion) given that there is not Figure 21: Central bank’s interventions to contain Figure 22: Despite sharp recovery of government money supply growth revenue, shortfall is estimated to be significant (LHS: NPR billion; RHS: percent) (LHS: in billion NPR, 3-month moving average, RHS: percent change, yly) Reverse Repo (RR) Deposit Auction (DA) Total Revenue Revenue growth (right) RR Interest Rate (right) DA Interest Rate (right) 40 40 120 6 30 30 100 5 20 20 80 4 10 10 60 3 0 0 -10 -10 40 2 -20 -20 20 1 -30 -30 0 0 -40 -40 Aug Dec Feb Apr Dec Feb Apr Feb Aug Aug Dec Apr Oct Jun Oct Jun Oct Feb Feb Feb Aug Apr Feb Aug Apr Apr Oct Aug Aug Apr Oct Dec Jun Dec Jun Oct Dec Jun Oct Dec FY14 FY15 FY16 FY13 FY13 FY14 FY15 FY16 Source: NRB Source: NRB and WB staff calculations Figure 23: Nearly half of government revenues de- Figure 24: Expenditure has picked up pend on trade (percent, share of total revenue) (LHS: in billion NPR, 3-month moving average, RHS: percent change, yly) Trade Taxes Non-Import VAT Non-Import Excise Expenditure Expenditure growth (right) 80 80 Income Tax Other Taxes Non-Tax Revenue 100 70 70 90 60 60 80 50 50 70 40 40 60 30 30 50 20 20 40 10 10 30 0 0 20 -10 -10 10 -20 -20 Aug Feb Apr Aug Feb Apr Aug Feb Apr Feb Oct Dec Oct Dec Apr Jun Jun Oct Dec Jun Aug Oct Dec 0 FY11 FY12 FY13 FY14 FY15 FY13 FY13 FY14 FY15 FY16 Source: MoF and WB staff calculations Source: NRB and WB staff calculations May 2016 THE WORLD BANK GROUP 8 Remittances at Risk Nepal Development Update enough time in the fiscal year to make up the for- of 2.7 percent (at market prices). The FY2015 gone revenue, particularly from the imports of estimate itself was revised down as well from a goods like petroleum, vehicles and fertilizers. previous estimate of 3.4 percent. Government spending has picked up faster, Industry has contracted for the first time in while capital spending is still lagging Govern- seven years. All sub-sectors contracted in activity ment spending growth, which was negative during during FY2016. Manufacturing, which was mostly the disruptions, has registered a sharp rebound. unaffected by the earthquake, has been hardest hit The total expenditure is up 14 percent in three due to its close proximity to protests that have halt- months ending mid-April 2016 compared to the ed transport entirely. Reports indicated that the sub same period in FY2015 (Figure 24). As the fiscal -sector was operating at only ¼ of capacity at the year is coming to an end, this growth is driven by peak of trade disruptions. Construction also con- both recurrent and capital expenditure which are tracted as works were stopped due to lack of fuel up, 9 and 24 percent respectively (Figure 25). and imported materials. Electricity production was Budget for FY2016 called for near doubling of affected as damages to generation capacity caused capital expenditure as a response to the devasta- by the earthquake that could not be repaired. In tion caused by the earthquakes which is now very total, industry contracted by 6.3 percent, down unlikely to materialize. Consequently, by mid-May from meager growth of 1.5 percent in FY2015. the amount spent on capital expenditure was just 20 percent of the total budgeted amount. Poor Services have been hit hard recording a lowest implementation of capital expenditure, which was growth rate in 14 years. Tourism, which had start- country’s systemic problem, has been further exac- ed to rebound from April/May earthquakes, has erbated by the trade disruptions. taken another blow as peak tourist season (September to November) coincided with the 6. In sum, FY2016 resulted in lowest growth in peak trade disruptions. Hotels reported 30 percent 14 years. occupancy rate (down from usual 85-90 percent rate during peak season), with many curtailing First estimate for FY2016 growth shows the services or closing altogether. Wholesale and retail economy barely escaped a recession growing trade suffered a first contraction in nine years as only 0.6 percent (at market prices). This is the trade disruption severely curtailed availability of lowest growth in 14 years and is 1.1 percentage goods. Transport and communications registered points lower than already weak growth in FY2015 a lowest growth in a decade as fuel shortage af- Figure 25: Driven by recurrent while capital spend- Figure 26: As a result, bunching of capex likely to ing is below last year’s get worse in FY2016 (percent change, 3-month moving average, y/y) (percent, share of GoN capex spent in final trimester) 80 Capital Expenditure in Last Trimester Growth of recurrent spending Growth of capital spending 77 60 76 75 40 74 73 20 72 71 0 70 -20 69 68 -40 67 Feb Feb Feb Dec Apr Aug Dec Apr Aug Dec Apr Aug Feb Dec Apr Oct Jun Oct Jun Oct Jun Oct 66 FY13 FY14 FY15 FY16 FY12 FY13 FY14 FY15 Source: NRB and WB staff calculations Source: NRB and WB staff calculations May 2016 THE WORLD BANK GROUP 9 Remittances at Risk Nepal Development Update fected transport activities. In total, services regis- erty during FY2015 and FY2016. Shortages of tered a growth of 2.7 percent, down from 3.7 per- goods have pushed up prices affecting welfare cent in FY2015. across the board with significant impact on the poor in Nepal, particularly those in urban areas. Agriculture output has suffered from the start. A majority of agricultural output is for subsistence Fuel related slowdown in economic activity purposes and was unaffected in the short-term by together with the increase in transportation trade disruptions. However, it was still a weak year prices hurt casual wage workers that derive a for agriculture with a growth rate that was less bulk of their livelihoods from wages. Income from than a half of a 10-year historical average. Poor wages accounts for anywhere between 30-50 per- monsoon rainfall this year and earthquake-related cent of the total income of urban Nepalis who are destructions have contributed to weak agricultural poor or vulnerable to falling into poverty. Social output. In addition, negative effects were com- services were curtailed during the trade disruptions pounded by unavailability of fertilizers as a result and transfers were not able to offset weakening of the trade disruptions. The production of rice, purchasing power of vulnerable groups given price the main crop, is estimated to be lowest in the last hikes induced by shortages. Furthermore, schools 7 years. Furthermore, pronounced drought during were reporting most of their bus fleet grounded the dry season (November through February) af- and over two million children missed school for fected the winter crop production as well. In total, more than three months. Schools in the Terai re- agriculture recorded a growth of 1.3 percent, up gion were particularly hard hit as the schools were from 0.8 percent in FY2015. forcibly closed due to strikes, long before the trade disruptions started. Out of minimum required Poverty impact and human costs of the trade school days of 180 in one year, schools were open disruptions were significant as well. The trade only 128 days in the districts of Terai, according to disruptions have further affected poverty reduc- the preliminary data from UNICEF. tion efforts which were already hampered by the earthquakes in 2015. Earlier estimations had sug- gested that the earthquakes could end up pushing an additional 0.7-1.0 million of Nepalis into pov- Figure 27: Economic growth for FY2016 is at a 14- Figure 28: And growth slowed across all three sec- year low tors (percent) (percentage points, contribution to growth) Post-shocks Pre-earthquake Pre-trade disruptions Agriculture Industry Services 7 7 6 6 5 5.0 5 3.0 4 2.4 4 3 1.5 3.7 2.9 1.1 2 0.7 0.5 3 6.0 1.8 4.8 4.8 1 1.3 1.6 1.7 1.6 2 4.1 0.4 0.2 3.4 0.4 0.3 0.5 0 2.7 1 -1.0 -1 0.6 0 -2 FY 10 FY 11 FY 12 FY 13 FY 14 FY 15 FY 16 2011 2012 2013 2014 2015 2016 Source: CBS and WB staff calculations Source: CBS and WB staff calculations May 2016 THE WORLD BANK GROUP 10 Remittances at Risk Nepal Development Update Box 1: New World Bank global poverty line Figure 29: Comparison of poverty rates using dif- The World Bank has used $1.25 as the global ab- ferent poverty lines. solute poverty line since 2008. This line was updat- ed to $1.90 in October 2015. The primary reason (percent of the population) for this update was to ensure that the global pov- erty line accurately reflects the evolving changes in Poverty Rate in Nepal in 2010/11 the cost of living around the world. Cost of living across the world is tracked by Purchasing Power National Poverty Line 25.2 Parity rates and this update to the poverty rate was based on the most recent exercise done in 2011. PPPs enable each country’s consumption data to be converted to internationally comparable dollars. USD 1.25, using 2005 PPP 23.7 Nominal exchange rates cannot be used for this purpose because they only reflect the relative value of goods that are traded between countries. USD 1.90, using 2011 PPP 14.9 In Nepal, the national poverty line, established in 2010/11 represents the expenditure required to meet the minimum food and non-food needs in 0 5 10 15 20 25 30 the country. Poverty has historically been meas- Source: WB staff calculations ured using Nepal Living Standards Survey carried out by the Central Bureau of Statistics (CBS). As a stronger than what we would have concluded result of the change in the global poverty line as based on 2005 PPPs and Nepal’s CPI movement. well as the change in the PPP conversion factor In other words, it turns out that the living stand- for Nepal, the poverty rate measured at interna- ards of Nepalis, evaluated in international terms tional poverty lines for Nepal has changed. Under using 2011 PPPs is actually better than what it was the 2005 PPP factors and the $1.25 a day measure, when evaluated using the 2005 PPP. 23.7 percent of Nepalis were poor. In comparison, under the 2011 PPP and the $1.90 a day poverty This should be interpreted as a recalibration as line, only 14.9 percent Nepalis were poor. The fact opposed to a decline in poverty rates using the that poverty is lower under a higher poverty line international line. This does not affect the na- appears counterintuitive. But the reason for that is tional poverty line, which should remain the pri- that the 2011 PPPs reveal that the Nepali rupee’s mary benchmark for poverty monitoring, as well purchasing power, relative to the US dollar, is as identifying and targeting the poor in Nepal. May 2016 THE WORLD BANK GROUP 11 Remittances at Risk Nepal Development Update B. Outlook, Risks and Challenges Following the two years of disappointing vival of transport, tourism, and full normalization growth, activity is expected to rebound mod- of wholesale and retail trade sub-sectors. estly. The rebound in growth is predicated on sta- bilization of the political process, start of the Fiscal deficit is expected to widen during the earthquake rebuilding efforts and the full normali- forecast, but to remain within manageable zation of supply of goods. Growth in FY2017 is limits. Government’s recurrent expenditure is forecasted to accelerate to 4.7 percent and is ex- expected to grow substantially in the forecast peri- pected to moderate in line with the country’s po- od owing to increase in earthquake related cash tential during FY2018 (Table 1). assistance and other social security expenditures. Slow pick up in capital expenditure, particularly On the supply-side, all sub-sectors are ex- those related to earthquake reconstruction, so far pected to perform better and grow in line had limited the size of deficit in FY2016. Howev- with their historical averages. Agriculture out- er, starting from FY2017 and for the remainder of put is expected to improve largely as the probabil- the forecast period, revenues are not expected to ity for a normal monsoon season has increased. grow as fast as expenditures leading to a fiscal def- Industry is expected to rebound in FY2017 as icit as reconstruction efforts take full shape. Simi- manufacturing, construction and electricity gener- larly, current account which had remained surplus ation sub-sectors recover. Manufacturing in par- in the past several years is expected to turn to defi- ticular is expected to get a boost starting from cit as remittances taper off and imports grow driv- FY2017 as the apparels and garment industry are en by the larger reconstruction efforts. getting a duty free access to the US market. As the reconstruction activities are expected to firmly The high inflation induced by the trade dis- take off in FY2017, the construction sector is ruptions is expected to moderate to single dig- expected to benefit. Hydropower projects which its towards the end of FY2016 as the effects of were delayed by earthquakes and trade disrup- trade disruptions on prices dissipate. Both tions are expected to be completed in FY2017 global oil prices and prices in India are expected to which will add a positive contribution from the remain around their present levels, providing a electricity generation sub-sector as well. Services favorable external outlook for lower inflation in are expected to rebound in FY2017 with the re- Nepal as well. However, inflation is likely to re- May 2016 THE WORLD BANK GROUP 13 Remittances at Risk Nepal Development Update Table 1 - Nepal Macroeconomic Outlook (annual percent change unless noted otherwise) FY2013 FY2014 FY2015 FY2016 FY2017 f FY2018 f Real GDP growth, at constant market prices 4.1 6.0 2.7 0.6 4.7 4.4 Private Consumption -6.7 10.0 7.4 -5.4 2.0 5.0 Government Consumption 2.7 4.2 2.9 -0.5 1.9 4.9 Gross Fixed Capital Investment 23.5 22.8 7.9 8.7 2.0 8.0 Exports, Goods and Services 10.3 18.8 6.8 -2.8 1.0 5.0 Imports, Goods and Services 14.1 21.0 9.6 3.3 15.0 5.0 Real GDP growth, at constant basic prices 3.8 5.7 2.3 0.8 4.7 4.4 Agriculture 1.1 4.5 0.8 1.3 3.0 3.0 Industry 2.7 7.1 1.5 -6.3 4.0 4.0 Services 6.2 6.1 3.7 2.7 6.0 5.5 Inflation (Consumer Price Index) 9.9 9.1 7.2 9.4 9.0 8.3 Current Account Balance (% of GDP) 3.4 4.6 5.1 5.0 0.5 -1.8 Fiscal Balance (% of GDP) 1.7 1.8 0.3 -0.1 -1.9 -1.5 Debt (% of GDP) 32.5 29.1 24.8 26.6 29.1 31.1 Primary Balance (% of GDP) 2.4 2.1 1.4 0.7 -1.3 -0.7 Sources: Central Bureau of Statistics and World Bank, Macroeconomics and Fiscal Management Global Practice for forecasts. Notes: e = estimate, f = forecast. main elevated owing to persistent supply-side bot- main at their current levels during the forecast pe- tlenecks, loose monetary policy and spending riod, the possibility of a slowdown in remittances pressures arising from pick up in reconstruction has increased. Given that remittances enable con- activities and government spending during the sumption-centric structure of the Nepalese econo- forecast period. my and the government’s reliance on taxation of imports as a major source of revenue, even a mod- Macroeconomic risks associated with this est contraction in remittance would have adverse baseline forecasts are on the downside and are effects on growth, fiscal and external accounts, in mostly of the domestic nature. The scale and addition to curtailing economic opportunities for pace of reconstruction is the largest source of un- Nepalis abroad. certainty given persistent challenges surrounding the institutional set-up required for effective tar- There are several near- and medium-term geting of the aid to earthquake-affected house- challenges ahead for Nepal. Normalizing fuel holds. Consequently, should the recovery effort and other supplies to general public, along with suffer further delays, the outcome will disappoint. effective mobilization of post-earthquake recon- Furthermore, significant political risks still exists. struction are key near-term challenges, particularly The underlying causes of discontent that resulted as the monsoon season approaches. Additionally, in protests and blockades have not been met and the trade disruptions have highlighted the need to could lead to further disruptions and disturbances. urgently diversify the Nepalese economy, particu- larly in terms of trade, transport options. External environment is expected to be less favorable as well. With remittances comprising In the medium-term, Nepal faces several sim- around 30 percent of GDP, Nepalese economy is ultaneous and daunting challenges ahead. extremely dependent on these flows. Oil- From completion of political transition and setting exporting Gulf Co-operation Countries and Ma- up of a new federal structure to challenges of suc- laysia, which represent almost 97 percent of total cessful leveraging of its endowments (hydropower Nepali migrants excluding India, are a key source potential, human capital) to achieve a faster of remittances. As oil prices in particular, and growth, increasing poverty reduction and creating commodity prices in general, are expected to re- economic opportunities for its citizens at home. May 2016 THE WORLD BANK GROUP 14 Remittances at Risk Nepal Development Update C. Special Focus: Remittances at Risk Summary  Remittances play a pivotal role in the Nepalese economy and the near-term risk of a possible slowdown has increased.  Growth of remittances at a global level has contracted in 2015—a first since 2008—primarily as a result of a fall in oil prices which has affected activity in remittance-sending countries.  Inflows of remittances to South Asian economies has declined as well, but inflows to Nepal buckled the trend as remittances increased significantly in response to the earthquake in April 2015.  However, prolonged contraction in departures of migrant workers is an early sign of a potential slowdown in remittances in Nepal. A potential slowdown of remittances poses a significant near term risk to Nepal because of its outsized role in the Nepalese economy.  A similar episode occurred in 2011, following the global financial crisis in 2008-09.  Should the slowdown in remittances occur, an appropriate monetary and fiscal policies responses are required as well as en- hanced supervision of the financial sector.  Furthermore, given the two shocks the country faced in 2015, Nepal’s ability to absorb a potential third shock has dimin- ished, requiring a concerted effort to weather it. 1. The role of remittances in Nepal’s making Nepal, among one of the highest economy remittances recipient countries in the world adjusted for the size of the economy. Around the turn of the century, Nepal’s economic landscape has been re-shaped On one hand, remittance inflows have by migration and remittances. Based on the enabled a higher growth of disposable data from Nepal Living Standards Survey income Gross National Disposable Income (NLSS), out of a total workforce of 14 million, (GNDI) grew nearly 1.5 times faster than the some 4 million or 28 percent of work force are overall national income (Gross Domestic believed to be working overseas today. At the Product of GDP). Between FY2000 to same time, the remittances have grown to FY2016, average per capita GNDI growth more than 30 percent of GDP (Figure 30), was 3.8 percent per year, while average per May 2016 THE WORLD BANK GROUP 15 Remittances at Risk Nepal Development Update capita GDP growth rate of 2.5 percent. In conflict, absorbing an ever greater share of turn, this has not only fueled consumption, new entrants into employment, particularly but also contributed to a dramatic reduction low skilled rural youth. in poverty, which fell by 28 percentage points between 2003-04 and 2010-11. In addition, On the other hand, over the past decade remittances contributed strongly to human and a half, Nepal has undergone atypical development via investments in education structural transformation. The movement of and health. Furthermore, migration acted as a labor out of agriculture was not triggered by safety-valve for a labor market constrained by new urban jobs in emerging Nepali cities and Figure 30: Remittances have grown to more than Figure 31: However, growth in remittances has 30 percent of GDP coincided with decline in manufacturing sector (LHS: NPR billion; RHS: percent of GDP) (percent of GDP) Remittances Remittances as share of GDP (Right) Manufacturing Remittances (right) 12 30 700 35 600 30 10 25 500 25 8 20 400 20 6 15 300 15 4 10 200 10 2 5 100 5 0 0 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 0 0 FY01 FY03 FY05 FY07 FY09 FY11 FY13 FY15 Source: CBS, NRB and WB staff calculations Source: CBS, NRB and WB staff calculations Figure 32: Remittances represent by far the most Figure 33: Remittance are crucial component of important external inflow for Nepal current account, highest in South Asia, and a sig- nificant portion of reserves in Nepal (percent of GDP) (percent) Exports (goods & services) FDI Foreing Aid Remittances Remittances as share of CA Remittances as share of Reserves 35 160 30 140 120 25 100 20 80 15 60 10 40 5 20 0 0 FY 12 FY 13 FY 14 FY 15 Nepal Pakistan Bangladesh Sri Lanka India Source: NRB and WB staff calculations Source: WDI, NRB and WB staff calculations May 2016 THE WORLD BANK GROUP 16 Remittances at Risk Nepal Development Update industries, but instead by foreign employment following the ratification of the nuclear opportunities. In turn, the remitted earnings agreement with the United States, and lower of Nepalis abroad have fueled an expansion of demand, partly due to a mild winter in the low skill services at home, while its northern hemisphere (World Bank, 2016). manufacturing base has stagnated (Figure 31). Despite some initial resilience, there has The reality is that remittances plays a been slowdown of remittances from the pivotal role in the Nepalese economy. They GCC countries too. Remittance outflows are a major stabilizer of Nepal’s current from the major oil-exporting countries of the account, as remittance flows amounted to 6.1 GCC have held up in 2015 as they have used billion USD in 2015. As such, they are 10 times their substantial reserves to maintain spending larger than foreign aid and 2.5 times larger than levels, and also because the GCC currencies total exports (Figure 32). In addition to being are linked to the U.S. dollar. Remittances from the largest component in current account of Saudi Arabia and Qatar, which account for Nepal, they also play an important role is around half of remittances sent from the maintaining foreign reserves of Nepal (Figure GCC, increased by 7 percent through the 33). Remittances are the transformative flow for third quarter of 2015. However, more recent the Nepalese economy, as they support the data from the fourth quarter, indicate a domestic consumption, savings and overall slowdown in remittances from the GCC growth in Nepal via ever growing service sector countries. If lower oil prices persist, (50 percent of GDP). Remittances are estimated remittance outflows from GCC countries are to constitute a quarter of the income of all likely to slow further (IMF, 2015). households and almost two-thirds of the income for those receiving money from abroad. The outlook for the price of oil is a major downside risk to the remittances forecast. 2. Recent global trends in remittances Moreover, in the face of the steep drop in the oil price, incomes in GCC countries have so far 2015 has recorded the lowest growth rate been supported by drawing down assets. A of global remittances flow since 2008 further decline in the oil price, or even growing financial crisis. The growth rate of expectation that the prices will not rise over the remittances to developing countries have medium-term, could encourage authorities to slowed down in 2015 to 0.4 percent from 3.2 adjust to lower oil prices. The result would be percent in 2014 and is estimated to be lowest reduced incomes for migrants in these countries, growth rate since the global financial crisis in and perhaps steps to restrict hiring of or even 2008. The slowdown in growth is largely repatriate foreign workers. This could attributed to economic weakness in the major substantially reduce remittances outflows to the remittance-sending countries. Weak oil prices Middle East, South Asia, and East Asia and the and currencies in many source countries Pacific (World Bank, 2016). further depressed remittance flows in U.S. dollar terms (World Bank, 2016). In 2015, remittances inflows declined in many countries in South Asia too, but Persistent weakness in oil and commodity Nepal was an exception. Remittances to prices are associated with the slowdown in South Asia rose by an estimated 2.0 percent in remittances. The continuing weakness in the 2015. While remittances to India and Sri price of oil and commodities, which in turn in Lanka declined, flows to Nepal increased affecting economic activities in remittance- significantly in response to the earthquake in sending countries, is reducing the growth of April-May. Remittances to India, the region’s remittances. Crude oil prices fell from around largest economy and the world’s largest USD51 per barrel (bbl) in October 2015 to remittance recipient, decreased by 2.1 percent below USD30/bbl in January 2016, driven by in 2015, to $68.9 billion. This marks the first robust production in the United States, decline in remittances since 2009. The growth unchanged OPEC policy, the earlier than of remittances in 2015 slowed from 8 percent expected resumption of Iranian oil exports in 2014 to 2.5 percent for Bangladesh, from May 2016 THE WORLD BANK GROUP 17 Remittances at Risk Nepal Development Update 16.7 percent to 12.8 percent for Pakistan, and Nepal rose dramatically in response to the from 9.6 percent to –0.5 percent for Sri earthquake, growing by 27.6 percent in three Lanka. Slower growth is estimated to have months to June 2015 compared to the same reflected the impact of falling oil prices on period the year before. However, following remittances particularly from GCC countries this peak, inflow of remittances has slowed (World Bank, 2016). down registering a single digit growth by January 2016. In three months to April 2016, 3. Recent trends in Nepal remittances have contracted by 5.3 percent (in US dollar terms) compared to the same period Remittance inflows to Nepal increased of previous year (Figure 34). significantly in 2015 in response to the earthquake in April. Most empirical studies Furthermore, a sharp decline in outflow of find that remittances tend to increase as a migrant workers has occurred following the result of natural disasters. Disasters generate earthquake. Following the April earthquakes, increased remittances if they are motivated by outflows of migrant workers has declined altruism, or reflect risk diversification by the significantly for ten months in a row with a household to cope with income volatility in contraction of 25 percent by April 2016 (y/y) the country of origin. Empirical work recently (Figure 35). This is one of the steepest and undertaken at the World Bank, including longest decline of migrant workers outflow country case studies and regression analysis of which has exceeded the migrants’ worker cross-country data, indicate that remittances contraction in 2009. One reason is the effect of to developing countries tend to rise earthquakes which led to potential migrants moderately following a disaster (World Bank, increasingly choosing to stay at home to 2016). In the case of Nepal too, remittances support their families with rebuilding homes growth rate which was 4.8 percent in March and livelihoods. In addition, a weaker demand 2015 (y/y in dollar terms) prior to the for workers from oil/commodity producing earthquake jumped to 11.2 percent (y/y) in host countries (e.g. GCC countries and June after the earthquake in April. Malaysia) is likely to have equally contributed to this decline (Figure 36). Malaysia in particular However, post-earthquake jump in has even announced a moratorium of foreign remittances is tapering off. Remittances to workers until further notice. Reportedly policy Figure 34: Growth in remittances has slowed down Figure 35: Outflow of migrant workers has continu- significantly since the peak in 2015 ously contracted since the earthquakes (LHS: in thousands, 3-month moving average, RHS: percent change, y/y) (LHS: in thousands, 3-month moving average, RHS: percent change, y/y) Remittances Remittances growth (right) Migrant Workers Outflow Migrant Outflow Growth Rate (right) 650 65 140 140 550 55 120 120 100 100 450 45 80 80 350 35 60 60 40 40 250 25 20 20 150 15 0 0 -20 -20 50 5 -40 -40 -50 -5 -60 -60 May May May May May May May Sep Sep Sep Sep Sep Sep Sep Jan Jan Jan Jan Jan Jan Jan Jan May May May Sep May Sep May Sep May Sep May Sep Sep Sep Jan Jan Jan Jan Jan Jan Jan Jan 2009 2010 2011 2012 2013 2014 2015 2016 2009 2010 2011 2012 2013 2014 2015 2016 Source: NRB and WB staff calculations Source: WDI, NRB and WB staff calculations May 2016 THE WORLD BANK GROUP 18 Remittances at Risk Nepal Development Update Figure 36: Significant drop in absolute number of Figure 37: Driven largely by a slowdown in Malay- registered migrant contracts in 2015 sia (in thousand) (male migrants, in thousand) Female Male Malaysia Qatar UAE Other Saudi Arabia 600 250 500 200 400 150 300 100 200 50 100 0 0 2008 2009 2010 2011 2012 2013 2014 2015 2008 2009 2010 2011 2012 2013 2014 2015 Source: : World Bank staff estimates based on DOFE data Source: World Bank staff estimates based on DOFE data announcement by the Government of Nepal offset the trade deficit leading to current requiring a free visa and a return air ticket for account surplus in Nepal (Figure 40). Given migrant workers and opposition to this policy Nepal’s large reliance on trade-related taxes, by manpower companies has further the possible slowdown in remittances will also exacerbated the flow of migrant workers slow revenue collection (Figure 41). In sum, a particularly those going to Malaysia. As a result, slowdown in remittances would not only slow drop in migrant workers going to Malaysia has economic growth, but also affect poverty been very pronounced (Figure 37). reduction and public revenues as well. 4. Risks to the Nepalese Economy Nepal experienced an episode of a slowdown in remittances in 2011 following Slowing down of departures of migrant the 2008-09 global financial crisis. The workers and potentially of remittances global financial crisis starting in 2008 led to pose a significant near term risk. In massive growth slowdown across the world. addition to the large role of the remittances Nepal was relatively unaffected by the crisis that can be measured through the formal due to its narrow exposure to the global channels, Nepal is also a recipient of a economy. However, the impact came via a significant remittances that are received remittance channel, albeit with some lag. informally and are, consequently, difficult to Weighted average GCC and Malaysia’s growth quantify. Furthermore, India, which is one of rate slowed to just 0.1 percent in 2009, down the largest destinations for informal Nepalese from a five years average of 7.3 percent prior migrants, is expected to grow more than 7 to the crisis (Figure 39). The effect of the percent in FY2016. This may help to absorb slowdown was clearly visible in t demand of some of the decline of migrants to GCC Nepali migrant workers which started to wane countries and Malaysia. Nonetheless, previous from the end of 2008 and ultimately experience shows that a slowdown in formal contracting in FY2009 (Figure 42). As a result, remittances is likely to cause a significant pain remittances—despite increasing in nominal in the Nepalese economy. In recent years, terms—registered a considerable drop as a growing remittances have fueled consumption percentage of GDP. They went from 21.2 and growth, resulted in growing imports and percent of GDP in FY2009 down to 18.5 trade deficit. Remittances were large enough to percent of GDP in FY2011. May 2016 THE WORLD BANK GROUP 19 Remittances at Risk Nepal Development Update The effect of the drop in remittances in and retail trade sub-sector, the largest share of FY2011 was felt across the Nepalese the service sector, as its growth rate dropped economy. The import growth slowed down to 1.7 percent in FY2011, down from 6.7 to 8 percent in FY2011, down from 37 percent in FY2010. The ultimate impact was percent in FY2010 and also down from a five- visible in the overall GDP growth rate which year average of 20 percent. As Nepal’s came in at 3.4 percent for FY2011 despite a revenue collection is highly dependent on good year in agriculture and industry. Service trade taxes, the tax collection growth also sector contributed only 1.1 percentage points slowed to just 1.1 percent (y/y) for FY2011. to the overall growth, with agriculture and The slowdown in imports affected wholesale industry contributing the rest. Slowdown in Figure 38: GCC contribute largest share of remit- Figure 39: Correlation between GDP growth rate of tances to Nepal GCC & Malaysia and remittances inflow to Nepal (percent, share in total migrant stock; percent, share in total remittances) (percent change) Migrants Remittances Remittances (growth) GDP growth (GCC & Malaysia) 35 70 30 60 25 50 20 40 15 30 10 20 5 10 0 0 2008 2009 2010 2011 2012 2013 2014 India Saudi Arabia Qatar United Arab Emirates -10 Source: WDI and WB staff calculations Source: KNOMAD, NRB and WB staff calculations Figure 40: Without remittances current account Figure 41: Trade taxes are highly dependent on would be in a significant deficit imports which are fueled by remittances (percent of GDP) (percent of GDP) Trade taxes Remittance (right) CA CA without remittances 9 35 10 8 30 5 7 0 25 6 -5 20 5 -10 4 15 -15 3 10 -20 2 5 -25 1 -30 0 0 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 Source: NRB, CBS and WB calculations Source: MoF, CBS and WB calculations May 2016 THE WORLD BANK GROUP 20 Remittances at Risk Nepal Development Update Figure 42: Recent slowdown in outward migration Figure 43: Slowdown in migrant workers in FY09, is larger than comparable one from 2009 followed by remittances slowdown in FY10 and FY11 had widespread impact on the economy (percent change, y/y, 6-month moving average) (percent change, y/y) Remittances growth Migrant Outflow Growth Rate Service Sector growth (right) Remittance as percent of GDP 100 45 Tax growth Migrant workers 9 80 35 7 60 25 5 40 20 15 3 0 5 1 -20 -5 -1 -40 May Sep May Sep May Sep May Sep May Sep May Sep May Sep Jan Jan Jan Jan Jan Jan Jan Jan -15 -3 2009 2010 2011 2012 2013 2014 2015 2016 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 Source: DoFE, NRB and WB staff calculations Source: NRB and WB staff calculations remittances slowed the growth in service poverty, while the resulting economic sector to 3.2 percent, down from a five-year slowdown could increase the number of non- average of 5.7 percent, which ultimately performing loans, requiring greater provisions slowed the overall growth rate as well. and capital buffers in the banking sector. Obviously, should the reduction in 5. Conclusion remittances be more pronounced, or last longer, the effects would be larger. A small decline in remittance can have large macroeconomic impacts. To be clear, Best response to such an exogenous shock we are not expecting a rapid drop in would be a well-designed endogenous remittances in Nepal. However, given the large policy response. Historically, growth in size of remittances, even a small slowdown in Nepal depended on exogenous factors, such remittance for Nepal can have a broad as a good monsoon for a bountiful harvest, macroeconomic, poverty and fiscal impacts. or, more recently, increasing external demand for Nepal’s labor that resulted in ever higher In a hypothetical scenario of a 10 percent remittances. Development was also hindered drop in remittances, the growth in Nepal by exogenous shocks, such as the April 2015 could drop by up to 3 percentage points earthquake. Clearly, a well-designed domestic compared to the baseline forecast. Given (endogenous) policy response to an external that a 10 percent drop in remittances is equal (exogenous) shocks can help Nepal not only to 3 percentage points of GDP, such weather a shock of slowdown in remittances, slowdown would affect incomes, and in turn but also lay foundation for delinking Nepal’s consumption as well as GDP, in a growth from external factors. commensurate amount. This means that, for example, in this would occur in FY2018, A classic policy response in time of an economic growth could decline from 4.4 output shock would be a Keynesian-type percent to just 1.4 percent, all other things fiscal policy response that increases being equal. Further, government revenues capital spending. For example, this spending would decline by about 1.5 percentage points could be directed towards a construction of a of GDP deepening the fiscal deficit as imports national irrigation system that not only buffers slow as well. A prolonged slowdown in effects on growth but also helps delink remittances may have an adverse effect on agricultural output from the effects of the May 2016 THE WORLD BANK GROUP 21 Remittances at Risk Nepal Development Update monsoon. This could be financed though References: issuance on long-term bonds that has a monetary policy effect of reducing excess Central Bureau of Statistics. 2013. "Nepal liquidity currently present. This would lower Living Standard Survey (NLSS) III." inflation and improve real effective exchange Kathmandu. rate and external competitiveness. Complemented by a stronger supervision of International Monetary Fund. 2015. "Regional the financial sector will strengthen banks’ Economic Outlook: Middle East and Central ability to buffer shocks. Asia." Washington DC. However, in the medium and long term, The World Bank. 2016. "Migration and Nepal needs to move out from an Development Brief 26." Washington DC. inherently risky strategy of relying on a single driver for growth that is vulnerable to external shocks. While healthy migration and related remittance flows will continue to play an important role for external balance and (disposable) income support, Nepal will need to leverage its key resources—human and natural capital—to attract investment and lay the foundations for creation of opportunities and economic diversification at home. May 2016 THE WORLD BANK GROUP 22 The World Bank Group Nepal Country Office, PO Box: 798 Yak and Yeti Hotel Complex Durbar Marg, Kathmandu, Nepal Tel: 4236000, Fax: 4225112 www.worldbank.org/np Email: infonepal@worldbank.org www.facebook.com/WorldBankNepal