Nepal’s Economy Steadies Amid Shocks, But Reform and Remittance Risks Loom Large

Nepal’s economy grew steadily in early FY2025 despite floods and tourism disruptions, supported by agriculture and hydropower gains. While inflation eased and fiscal health improved, falling remittances, financial sector stress, and delayed reforms pose ongoing risks.

The Nepal Development Update (April 2025), authored by the World Bank’s Economic Policy team for Nepal with inputs from the Ministry of Finance, Nepal Rastra Bank, and CDS and Clearing Limited, paints a cautiously optimistic picture of Nepal’s economic performance. Despite battling climate disasters and global economic uncertainties, Nepal posted a 4.9 percent GDP growth in the first half of fiscal year 2025 (H1FY25), up from 4.3 percent the previous year. Growth was fueled by the rebound in agriculture and industry, even as the services sector faltered due to natural disasters and infrastructure disruptions. Severe flooding in September 2024 and a major airport renovation project slowed the pace of recovery, but the country’s macroeconomic indicators continue to show signs of resilience.

Floods, Flights, and a Fragile Services Sector

The September 2024 floods proved to be a significant setback, causing damage equivalent to 0.8 percent of GDP. The most affected region was Bagmati Province, where roads, hydropower plants, and agricultural land were devastated. Thousands of homes were damaged or destroyed, displacing nearly 11,000 families. Meanwhile, the Tribhuvan International Airport (TIA) upgrade, a critical infrastructure project, created its own set of disruptions. Operating hours were reduced, flight delays became routine, and tourist arrivals declined. The accommodation and food services sector, previously one of Nepal’s fastest-growing industries, plunged from a growth rate of 27.2 percent in H1FY24 to just 5.3 percent this year.

Tourism woes aside, the agriculture sector offered a silver lining. A favorable monsoon led to a 4 percent increase in paddy production and a 5.8 percent rise in yield. Even in the face of flood-related setbacks, the southern Tarai belt, Nepal’s food basket was less affected, helping sustain overall output. The industrial sector also expanded by 6.6 percent, driven largely by increased hydropower generation and a rebound in manufacturing, particularly refined edible oils and alcoholic beverages.

Inflation Moderates, But Food Prices Still Bite

Average headline inflation eased to 5 percent in H1FY25, aligning with the Nepal Rastra Bank’s inflation target and significantly lower than the 6.5 percent seen the year before. This moderation was due to declining prices in housing, utilities, and restaurant services. However, food and beverage prices remained stubbornly high, with vegetable inflation soaring by 26.6 percent. The government’s attempt to mitigate this by removing VAT on select produce had only a limited effect, especially given that Nepal’s currency peg to the Indian rupee means it remains exposed to inflationary pressures in India.

From a demand perspective, private investment remained subdued. Credit to non-financial businesses rose only 6 percent, well below historic averages, and overall credit to the private sector declined. Public investment saw only a modest improvement. Exports and imports both increased slightly, but exports of refined edible oils played an outsized role, benefiting from India’s tariff adjustments and Nepal’s zero-duty trade access under SAFTA.

External Balances Stable, But Remittances Slide

Nepal’s external sector showed some softening, with the current account surplus slipping to 2.4 percent of GDP, down from 2.8 percent in H1FY24. A key factor was the drop in remittance inflows, which fell from 12.9 percent of GDP to 12.4 percent. This was due to a significant fall in labor migration, especially to Malaysia, following that country’s cap on foreign workers. Although migration to the UAE and other destinations increased, it was not enough to offset the loss.

On the trade front, imports of goods and services dropped to their lowest levels since H1FY16, led by declining petroleum and travel-related imports. Exports rose modestly thanks to increased shipments of refined edible oils. However, exports of electricity and several NTIS-priority goods like footwear and cement declined, hampered by flood damage to power stations and difficulties in securing Indian regulatory approvals.

Despite the dip in remittances and trade frictions, foreign exchange reserves remained robust, covering 14.4 months of imports. The central bank’s accommodative monetary policy, including rate cuts totaling 150 basis points since FY24, helped ease credit conditions, though demand remained weak. Excess liquidity was mopped up through open market operations, mainly via the standing deposit facility introduced in early 2024.

Financial Sector Strains and a Return to the FATF Grey List

The financial sector is under stress. Non-performing loans (NPLs) hit a record 4.9 percent, triggering a rise in loan-loss provisions and a drop in profitability across commercial banks and finance companies. Nevertheless, capital adequacy remains above the regulatory minimum, aided by forbearance measures from the central bank, including reduced provisioning and relaxed risk-weight norms.

On the international front, Nepal made headlines after receiving its first sovereign credit rating BB- with a stable outlook from Fitch Ratings in November 2024. However, just months later, the country was added to the Financial Action Task Force (FATF) Grey List due to deficiencies in its anti-money laundering framework. This could impact investor confidence and increase transaction costs, especially for remittances and foreign direct investment.

Reform Momentum and the Road Ahead

Nepal’s fiscal performance has been encouraging, with the deficit narrowing sharply to near zero in H1FY25. Revenue growth, supported by higher excise duties, capital gains tax from a booming stock market, and improved dividend collection, outpaced modest spending. Capital expenditure, while higher, still lags behind debt servicing obligations. Public debt declined slightly to 41.1 percent of GDP and remains sustainable, with most borrowing sourced domestically amid lower interest rates.

Looking forward, GDP is projected to grow 4.5 percent in FY25 and average 5.4 percent through FY27. Inflation is expected to decline further, while the current account surplus will likely shrink due to slower remittance growth and rising imports. Risks remain from geopolitical shocks to domestic implementation gaps. But the recent passage of five reform ordinances aimed at strengthening governance, business climate, and investment could be transformative if followed through. As Nepal continues to grapple with complex structural challenges, consistent policy execution and private sector-driven growth will be essential to ensure a more resilient and inclusive economy.