South Asia in Focus : Economy in Peril
March 30, 2023
Sri Lanka is in a grave economic crisis. Is Nepal Next?
Sri Lanka is currently facing a severe economic crisis, marked by a rapid decline in foreign exchange reserves, leading to a scarcity of essential goods. Although Sri Lanka's economy is about twice the size of Nepal's, its foreign currency reserves are only NPR 280 billion, compared to Nepal's NPR 1147 billion as of mid-February 2022. Both economies heavily rely on tourism and remittances for capital inflow. The COVID-19 pandemic severely impacted Sri Lanka's tourism sector, depleting its foreign currency reserves and escalating into a humanitarian crisis. Nepal faces a similar risk, with its foreign currency reserves also depleting rapidly.
Nepal finances its imports (such as petroleum products, electronic devices, and consumer goods) through foreign currency reserves. Last year, Nepal imported goods and services worth NPR 1539 billion but only exported NPR 141 billion worth of goods and services. The deficit was partially offset by remittances amounting to NPR 875 billion. Other investments and changes in ownership of financial assets resulted in a Balance of Payment (BOP) surplus in 2021.
Balance of payment is the difference between all money flowing into the country in a particular period and the money outflow from the country to the rest of the world. a
Table 1 – BOP Deficit Each Year
Table 1 is an illustration of balance of payments starting from 2016/17. The balance of payments deficit of NPR 247 billion in just seven months of 2021/22 is alarming because the deficit eats up on our reserves. Table 2 below shows our foreign currency reserves at the mentioned dates.
As of mid-February 2021, Nepal's foreign currency reserves stood at NPR 1462 billion, a comfortable safety net. By the end of 2021, reserves slightly decreased to NPR 1399 billion. However, as COVID-19 restrictions eased and imports soared, reserves further declined to NPR 1173 billion by mid-February 2022. Although this figure isn't immediately alarming, the rapid decline in forex reserves and the BOP deficit indicate potential future risks if the current trend continues.
In the last seven months of 2021/22 alone, imports surged to NPR 1147 billion. Despite a similar percentage growth in exports, the export figures, standing at NPR 132 billion, were dwarfed by the massive imports.
Table 3: Exports and Imports of Nepal, Seven Months (Mid July - Mid- February, 2020-2022)
The Danger
If the current pace continues, Nepal risks depleting its foreign currency reserves, affecting its ability to service debts and import essential goods.
Current Measures
The government and Nepal Rastra Bank (NRB) have introduced several measures to control capital flight. NRB has banned Nepalese nationals from investing in cryptocurrencies and increased cash margins on various goods to control imports. Additionally, the government has reduced the minimum foreign exchange requirement for Nepalese traveling overseas to limit currency outflow.
Short-Term Solutions
The government can reduce imports through increased tariffs, while NRB can raise interest rates to discourage consumption, which would help limit consumer goods imports. If the situation worsens, stricter import restrictions or bans may be necessary. Higher interest rates could negatively impact on the share market, as they tend to correlate with lower equity prices.
Long-Term Solutions
Nepal cannot sustain a prolonged BOP deficit. To avert a crisis, the country must increase exports and reduce reliance on imports. One major import is energy. Policies should be implemented to promote the use of home-produced electricity over petroleum products. Additionally, Nepal should identify and support industries with competitive advantages, facilitate international market access, and crack down on unofficial remittance channels like hundi. Strengthening property rights and easing business conditions for foreign investors can also help increase foreign direct investment, boosting capital inflows.
