Economic Outlook for Nepal: Recovery and Challenges Ahead

Updated 2026/01/04 . 11 min read . 0 comments

The situation with the economy of Nepal seems worse. But still, there is some chance for improvement. Putting aside, rather weighing more, the internal political instability, the COVID-19 pandemic, its aftermath, and the Russia-Ukraine, Israel-Hamas conflict made it very difficult for the Nepalese economy to move towards consolidation. To grasp the overall picture of the Nepalese economy, we need to explore its basic economic components.

Economic trends

Recent economic trends indicate that the Nepalese economy has started recovering remarkably during the first half of FY24, projected at 3.3%, up from its low of 1.9% in FY23, mainly driven by the services sector, accommodation, and food services to be particularly, supported by an increase in tourist arrivals. Similarly, growth in the financial and insurance sector was observed, while the wholesale and retail trade contracted.

Nepal’s economic growth is set to rebound, from 1.9 percent in FY23 to a forecast 3.3 percent in FY24. Growth is then projected to further accelerate to 5 percent on average, over FY25-26. Although this is seen to be at a modest growth rate of 3% during FY2023/24, this will increase to 4.9% during FY2024/25 due to improving domestic demand. It is expected that inflation will be within the 5.5% target of the Nepal Rastra Bank.

The industrial sector contributed positively to this growth, mainly due to hydroelectric production. Agriculture also improved due to the increase in seed availability and favorable weather, thus increasing paddy production. Domestic demand increased because private consumption went up, helped by a flow of remittances. However, despite the increase in remittances, there has been no corresponding rise in the imports of consumption goods since (first half of the year) H1FY21.

The private investment is subdued, which is reflected in the decline in imports of capital and intermediate goods. Austerity measures and lower revenue collections have led to a contraction in public consumption and investment. Notwithstanding this, the external economic position of Nepal has strengthened, reflecting a current account surplus. The current account balance changed from a deficit of 0.7% of GDP in H1 FY23 to a surplus of 2.7% in H1 FY24, largely on account of an increase in remittances and compression in the trade deficit. Remittances increased from 10.9% to 12.3% of GDP, while the trade deficit compressed from 13.2% to 11.6% of GDP.

In FY24, consumer price inflation is expected to remain high at 6.7 percent, close to the central bank’s 6.5 percent ceiling, due to VAT exemptions removal, India’s food export restrictions, and increased paddy minimum support prices. However, inflation is forecasted to decline to 6 percent in FY25 and 5.5 percent in FY26, driven by global commodity price moderation and domestic price containment through monetary policy. Projected lower inflation in India may also help reduce domestic inflation via the currency peg, mitigating imported inflation.

Inflation was subdued, with average consumer price inflation falling from 8% in H1 FY23 to 6.5% in H1 FY24, though food inflation rose due to India’s rice export ban. The incidence of poverty has been significantly reduced, as the Nepal Living Standard Survey reported from 2011 to 2023 a decline from 25% to 3.6%, although challenges persist in the labor market and social assistance sectors.

Among the key economic developments that cropped up during the FY 23/24 were: an annual average inflation rate of 5.44 percent, a decline in imports and exports by 1.2 percent and 3.0 percent, respectively; remittance inflows increased by 16.5 percent in Nepalese rupees and 14.5 percent in U.S. dollars; Balance of Payments stood at a surplus of Rs. 502.49 billion against Rs. 285.82 billion in the previous year. Gross foreign exchange reserves increased to USD 15.27 billion, sufficient for 13 months of imports. Broad money went up by 13%, while credit to the private sector rose by 5.8%.

While goods imports declined, there was a remarkable surge in electric car imports following lower tax rates; service imports were also well above pre-pandemic levels, in particular, education. Exports of goods and services experienced only a modest increase, remaining below pre-pandemic levels, although international tourist arrivals and electricity exports went up. Official remittance inflows reached an eight-year high in H1 FY24 driven by increased out-migration and currency depreciation, with foreign exchange reserves covering 12.1 months of imports.

The fiscal deficit improved, narrowing to 0.4% of GDP in H1 FY24 on the back of reduced spending. However, half-year revenue declined to an eight-year low of 8.7% of GDP largely driven by lower VAT and income tax collections. Revised the budget for FY24 downward to improve execution at sub-national levels. Public debt has slightly increased but remained sustainable underpinned by concessional external loans and prudent fiscal management.

Nepal’s fiscal deficit is poised to decrease significantly from its peak in FY23 (about 6 percent of GDP), stabilizing around 3 percent of GDP in the medium term, despite a projected higher deficit in FY24 compared to the government’s revised forecast. Revenue is expected to rise to 20.1 percent of GDP by FY26, supported by robust GDP growth and increased goods imports. Meanwhile, spending is expected to increase to 22.8 percent of GDP by FY26, driven by enhanced execution of public investment. The National Project Bank’s integrated guidelines, introduced in March 2023, aim to streamline project development and prioritization, contributing to more effective capital spending by FY25. Financing for the fiscal deficit will likely come from external concessional borrowing and domestic sources. However, public debt is projected to decline to 40.8 percent of GDP by FY26 from its FY23 peak because of higher economic growth.

According to the Ministry of Finance, the trade deficit of Nepal has expanded since 2008 from 14% to more than 50% of GDP, while national debt quadrupled to $14 billion. Debt servicing is now gobbling up more than one-third of tax revenues, forcing the government to seek new borrowings to pay interest on outstanding borrowings. Moreover, the GDP share of the manufacturing sector has almost halved, suggesting deindustrialization. Besides, fiscal discipline is weak, with falling tax revenues.

The total trade deficit shrank by 1 percent to Rs. 1,440.60 billion, whereas exports to China jumped by 46.6 percent, while exports to India and the rest of the world decreased. The merchandise imports from China increased by 34.2 percent whereas it decreased from the rest of the world. The number of Nepali workers seeking foreign employment approvals has slightly declined compared to the same period last year.

The current account balance is forecasted to return to surplus in FY24, driven by robust remittance growth and a narrowing trade deficit, but is expected to narrow subsequently as remittances taper off and the trade deficit expands. The trade deficit is expected to improve in the medium term, falling below its FY23 level. This is due to a projected decline in goods imports in FY24, although imports are expected to rebound in FY25 and FY26. Goods exports, particularly in electricity, are expected to increase. While services exports could rise with tourism recovery, services imports may surpass exports due to continued emigration. Despite efforts to attract more foreign direct investment, inflows are likely to remain modest.

During September 11-22, 2024, Ms. Sarwat Jahan led an International Monetary Fund (IMF) staff team on a visit to Kathmandu to discuss recent macroeconomic developments and the implementation of the Extended Credit Facility (ECF)-supported program. Following the visit, Ms. Jahan released a statement by mentioning of “Nepal’s economy is displaying early indications of improvement. Recent high-frequency data indicates a shift to positive import growth, enhanced tax collections, and increased public investment. Credit growth is rebounding while staying appropriately below nominal GDP growth. Inflation has continued to decrease, reaching around 3.6 percent by mid-July, partly due to favorable commodity prices and subdued demand. International reserves have continued to rise, supported by strong remittances, recovering tourism, and restrained imports.”

The IMF Executive Board concluded the fourth review of the ECF program for Nepal and approved access to SDR 31.4 million US$ 41.3 million. This has been despite an impoverished political environment in Nepal. Nepal has implemented its program despite significant political challenges; its economic activity is recovering, and better momentum is expected from supportive monetary policy, increased capital spending within the FY2024/25 budget, increased hydropower generation, and a rise in tourist arrivals.

As of July 9, 2024, total disbursements under the IMF ECF for Nepal reached SDR 188.3 million (approximately US$ 247.7 million). Initially approved in January 2022 for SDR 282.42 million, about US$ 371.6 million, the ECF program has helped Nepal cushion the pandemic and global shocks while protecting the vulnerable population and preserving macroeconomic stability.

Risks and Challenges

There are risks related to delay in capital project execution, political instability that shall affect policy implementation, and financial sector vulnerability due to a rise in non-performing loans. Externally, high commodity prices may also delay recovery in energy-intensive sectors, while Nepal remains vulnerable to natural disasters.

The International Monetary Fund projects that GDP growth may reach 4.9% by FY2024/25, while inflation stabilizes around 5.2%. Growth is expected to be led by capital expenditure, expanded hydropower projects, and rising tourism. There are, however, still major political and economic risks.

Looking ahead, the IMF projects GDP growth to reach 4.9% by FY2024/25, driven by capital expenditure, hydropower projects, and increased tourism. However, the economy still faces significant risks, including political instability, delayed policy implementation, and vulnerabilities in the financial sector. Externally, high commodity prices and Nepal’s exposure to natural disasters remain concerns.

The forecast is subject to both domestic and external risks. Externally, geopolitical uncertainty could trigger a rise in commodity prices, impacting all sectors. A growth slowdown in partner countries might also lead to a drop in remittances and tourism, hindering economic growth. Persistent inflation expectations and lower domestic demand could further dampen economic activity. Natural disasters pose additional risks to sustaining welfare gains. Finally, frequent political changes, a top headwind for businesses for over a decade, could continue to deter private investment.

Future Strategies

Efficient implementation of planned capital expenditure, alongside strengthening public investment management and fiscal transparency, is critical for achieving higher economic growth in Nepal. Additionally, monetary policy should be cautious to maintain price stability and external balance, while ongoing financial sector reforms are vital for ensuring a sound banking system. Strengthening Nepal’s Anti-Money Laundering and Combating the Financing of Terrorism regimes, alongside continued structural reforms, will enhance investment and foster inclusive growth.

It is crucial to accelerate the momentum of reforms to steer the economy towards sustainable, robust, and inclusive economic growth. This necessitates improving the execution of public investment, further enhancing domestic revenue mobilization, and timely disbursement of Child Grants. Continued vigilance is essential as banks address elevated non-performing loans and capital constraints, including through ongoing strengthening of regulation and completion of the loan portfolio review of the largest 10 banks. Addressing vulnerabilities among the savings and credit cooperatives remains a priority.

Data from H1FY24 underscores the structural challenges facing Nepal’s economy. On the fiscal side, the need to improve the execution and efficiency of capital expenditure to stimulate growth is apparent. Reducing dependence on import tax revenue is also necessary. Furthermore, consistent monetary policies are essential to restore confidence and support economic growth. Addressing the rise in non-performing loans in the financial sector is critical for maintaining financial stability and encouraging private investment.

The recovery is largely attributed to the easing of monetary policy, assuming productive use of private sector credit. Additionally, reforms to improve business environment could attract more private investment, further boosting medium-term growth prospects.

Externally, Nepal’s heavy reliance on remittance inflows leaves it vulnerable to external shocks. To mitigate this, the country must strengthen its international competitiveness, particularly by boosting exports in tourism, foreign direct investment, and goods. Nepal must move beyond its traditional reliance on remittances and tourism, exploring growth in agriculture, energy, and other industries. A collaborative effort between the government and private sector is essential to facilitate this economic transition.

Nepal can draw valuable lessons from global crises such as the pandemic, the war in Ukraine and Israel-Hamas, and Sri Lanka’s economic challenges. Based on these insights, the following measures are recommended for economic recovery:

Secure domestic food supplies by reducing and substituting agricultural imports.
Reduce reliance on fossil fuels, boost hydroelectric power capacity, and strive for energy self-sufficiency.
Diversify foreign currency reserves to safeguard against external shocks.

While the COVID crisis accelerated the decline of Nepal’s industry and service sectors, the agricultural sector presents a promising opportunity. Agricultural independence is crucial for attaining food security, controlling inflation, alleviating pressure on foreign reserves, and fortifying the economy.

The government should prioritize the commercialization of agriculture by building infrastructure to support production and distribution, and collaborating with the private sector to develop competitive markets. Policies that encourage private investment in agriculture, establish small and medium industries, and support indigenous products through access to agricultural finance are essential. Agricultural cooperatives also play a significant role in this strategy.

To increase agricultural exports, Nepal should fully utilize existing trade concessions and duty-free market access before graduating from the Least Developed Countries (LDC) category in 2026. The government must engage in proactive trade negotiations and leverage bilateral, multilateral, and regional forums to enhance market access.

Foreign direct investment (FDI) represents a sustainable source of foreign exchange for Nepal. A study by the Policy Research Institute emphasized the importance of aligning regulatory frameworks to create a conducive environment for sustainable agricultural and industrial growth. After Nepal graduates from LDC status in 2026, opportunities for resource mobilization in international capital markets will emerge, especially as its credit rating improves.

Nepal’s foreign exchange reserves have been impacted by rising fossil fuel prices, driven by global supply chain disruptions. This has also contributed to a rise in the consumer price index. To counter this, Nepal should prioritize the production and use of renewable energy, reduce fuel consumption, and combat climate change and air pollution. Efforts should focus on expanding electricity sales to energy markets in India and Bangladesh, as well as strengthening infrastructure for power transmission. The recently approved Millennium Challenge Corporation Compact (MCC) provides an avenue for such developments, but major reforms in existing climate policies are also needed.

The services sector is expected to be the key driver of growth in the coming years. Accommodation and food services are poised to benefit significantly from the rise in tourist arrivals. The ongoing construction of new five-star hotels and government policies supporting real estate loans are expected to further stimulate the accommodation sub- sector. Meanwhile, the industrial sector is expected to grow, buoyed by significant expansions in electricity generation capacity, fostering a more conducive environment for industrial activities.

The Deputy Managing Director of the IMF, Bo Li, acknowledged the key reform measures taken in Nepal’s economy. He observed that monetary policy and bank regulation went a long way in dealing with the pressures on the balance of payments. Though reserves are improving, fiscal discipline was necessary given the challenges on the revenue side and there has been some strengthening in the financial sector through improved regulatory practices.

The Nepalese economy displays a dualistic nature: while the external sectors—remittances and tourism—are performing relatively well, internal production and the labor market remain sluggish. Historic challenges, including insufficient investment in strategic infrastructure and political instability, continue to hinder economic progress. Reversing these trends requires sustainable development programs in agriculture, industry, tourism, and hydropower, supported by sound political reforms and governance.

A comprehensive understanding of the factors driving youth migration and a commitment to sustainable development are key to guiding Nepal towards a resilient economic future.