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UNCLAS SECTION 01 OF 02 KATHMANDU 000084 
 
SIPDIS 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON NP
SUBJECT: NEPAL'S ECONOMY FACES MAJOR CHALLENGES 
 
¶1. (SBU) Summary:  Nepal's economy, already damaged by a 
decade of civil conflict, faces balance of payments and 
liquidity problems, a real estate price bubble, slowing 
remittance growth, and a shaky (and partially unregulated) 
banking sector.  The IMF, central bank and leading bankers do 
not warn of an imminent economic or banking crisis, but they 
acknowledge there are danger signs.  End Summary. 
 
Balance of Payments and Liquidity Challenges 
-------------------------------------------- 
¶2. (SBU) Nepal is facing its first balance of payments 
deficit in many years.  In the first quarter of the current 
fiscal year, which began in mid-July, the deficit totaled Rs. 
20.5 billion (about USD 280 million), compared to a Rs. 11.8 
billion surplus in the same period last year.  During a 
January 26 meeting with the Charge, Krishna Bahadur 
Manandhar, Acting Governor of the Nepal Rastra Bank (NRB), 
the country's central bank, blamed the deficit largely on a 
Government of India's decision to increase tariffs on gold 
imports, while Nepal kept it tariff rate the same.  Illegal 
traders took advantage of this gap to import gold into Nepal, 
then smuggle it across the open Nepal-India border.  The 
Government of Nepal (GON) has taken several steps, including 
slowing the customs clearance process, to rein in gold 
imports, which totaled 12.5 tons over the first six months of 
FY 2009/10, more than triple the amount imported during the 
same period last year. 
 
¶3. (SBU) Nepal has also been experiencing a liquidity crunch, 
which pushed interest rates to 11-13 percent, up from 5-7 
percent last year.  Manandhar linked the ongoing liquidity 
crunch to the balance of payments deficit.  The head of the 
Nepal Banker's Association, Sashin Joshi, told Charge that 
irresponsible bank lending also contributed to the liquidity 
crisis, as bank lending exceeded deposits.  Other factors 
include the lack of government spending (the Maoist blockade 
of parliament delayed passage of the budget vote for four 
months) and last September's currency note shortage -- a 
result of poor planning by the NRB.  The latter decreased 
confidence in the banking sector and led to more Nepalis 
holding currency.  To combat the liquidity crunch, the NRB 
injected approximately Rs. 25 billion into the market, which 
began to ease the credit crisis.  IMF's representative in 
Nepal, Alexander Pitt, is "confident" the NRB's interventions 
will be effective.  (Note: Pitt is the only expatriate IMF 
staff in Nepal, and his office is inside the Nepal Rastra 
Bank.  End note.) 
 
Remittances Still Increasing, but at Slower Rate 
--------------------------------------------- --- 
¶4. (SBU) In recent years, banks have come to rely heavily on 
the flow of remittances from Nepalis working abroad, Joshi 
said.  Last fiscal year, remittances, which amount to more 
than 20 percent of GDP, grew by 65 percent, while the growth 
rate so far this years has been just 6 percent.  The dramatic 
growth in remittances in recent years, IMF's Pitt reported, 
has become "addictive" for banks, who rely on the flow of 
hard currency for their operations.  Banks are having some 
difficulty adjust to the slower rate of remittance growth. 
Pitt said that the continued strength of the Asian economies, 
where many Nepalis work, has kept remittance flows from 
dropping. 
 
Banking Sector Exposed, Partially Unregulated 
--------------------------------------------- 
¶5. (SBU) The dramatic rise in real estate prices -- some 
estimates suggest they have tripled in the past year -- 
creates risks for Nepal's banks.  While the majority of 
lending is for trade and manufacturing, some banks are 
significantly exposed in the real estate market. 
Additionally, as one prominent banker told the Charge, 
regardless of their purpose, "all the loans are 
 
KATHMANDU 00000084  002 OF 002 
 
 
collateralized by real estate."  It is unclear how many of 
the real estate loans are purely speculative versus real, 
according to IMF representative Pitt.  NRB chief Manandhar 
said his concern is not that real estate prices will begin to 
fall, but rather the rate of increase will slow, which would 
spell trouble for banks. Pitt agreed "danger signs are 
there," but added a "mass banking collapse" is unlikely. 
There is no deposit insurance in Nepal, increasing bank 
instability, although the NRB has recommended to the GON that 
they consider developing an insurance scheme. 
 
¶6. (SBU) NRB's Manandhar is "seriously concerned" about the 
growth of cooperatives, a Nepali financial institution 
similar to credit unions.  Cooperatives are beyond the 
jurisdiction of the NRB, and while the Ministry of Finance 
technically oversees the more than 15,0000 cooperatives, it 
lacks resources and capacity needed for effective 
regulations.  Banker's Association President Joshi, who 
estimates cooperatives' assets total  Rs. 60 to 65 billion, 
said managers of some of the large cooperatives invest 
deposits largely in high-risk real estate deals, while 
maintaining reserves as little as one percent.  He cautioned 
that, once the real estate market slows, cooperatives could 
begin to fail, and, if one fails, it could create a panic. 
 
Keep the Indian Currency Peg 
---------------------------- 
¶7. (SBU) The IMF and NRB both strongly support the current 
policy of pegging Nepal's currency to the Indian rupee. 
NRB's Manandhar said allowing the Nepali rupee to float would 
be a "lose-lose proposition."  IMF's Pitt said the peg was a 
"pillar of stability," adding the NRB does not have the 
capacity to manage a floating exchange rate.  Given the thin 
market for Nepali rupees, the both argued, a floating 
exchange rate would also invite speculation. 
 
Macroeconomic Picture Generally Stable 
-------------------------------------- 
¶8. (SBU) Despite the many economic challenges, Pitt reported 
that Nepal's overall macroeconomic picture is generally 
sound.  This year's budget deficit may slightly exceed the 
IMF recommended target of 2 percent, due to unbudgeted 
demands such as increases in civil service salaries and 
payments to former Maoist combatants, but revenues are doing 
well.  The IMF does not have a program in Nepal, but plans to 
start discussions with Nepal on a precautionary program, 
likely focused on financial sector reform.  The next IMF 
Article IV visit is scheduled for February 24. 
ORDWAY