Reeling From a Forex Crunch, Is Nepal Staring at a 'Sri Lankan Scenario'?

Nepal has decided to suspend the import of 10 luxury items, including toys and playing cards.

An economic crisis in looming over Nepal.

The government has, via a notice issued on 26 April, decided to suspend the import of 10 luxury items until end of the fiscal year 2021-22.

Chips, cigarette and tobacco products, vehicles, toys, and playing cards are some of the items that are included in the ban.

The reason behind such a drastic step is the government's depleting foreign reserves, a situation that sparked a catastrophic economic meltdown in Sri Lanka earlier this month.

Why is Nepal facing a forex crisis? What are the factors behind it? How similar is Nepal's situation to Sri Lanka's? And what can Nepal do to avoid the calamity that Sri Lanka is facing?

The Numbers

Let's begin with Nepal's currency – the Nepalese Rupee (NPR) – whose value has gone down by 38 percent in the last 10 years.

Nepal's balance of payments (BOP) is at a deficit of NPR 258.64 billion, whereas only two years ago, the BOP was a surplus of NPR 282.41 billion.

The trade deficit is at $9.5 billion, with imports amounting to $10.7 billion and exports totaling to $1.2 billion.

Remittances have plummeted as well, and the sharpest drop came in March earlier this year, when they reduced by NPR 330 billion since July 2021, according to the Times of India.

The inflation rate at the moment is around 7 percent but it is expected to cross double digits next year, according to the central bank’s estimation.

On fuel imports, Nepal’s bill crossed NPR 1 billion a day by mid-April and the Nepal Oil Corporation (owned by the state) recently declared that it had no money.

To put that into perspective, in April last year, the cost of 1 litre of petrol was NPR 120, which has now spiked to NPR 160 (a record high).

In fact, the Nepalese government earlier this week approved of a two-day weekend that would begin on 15 May, most likely to reduce the movement of vehicles in order to cut fuel costs.

The Forex Crunch

According to the data provided by the central bank, Nepal's gross forex reserves have dropped by 17 percent, that is, to $9.75 billion from $11.75 billion in July last year.

Why is this happening? There are several reasons. Speaking to The Quint, Sunil Kumar Chaudhary, a Research Associate at the Nepal Institute for International Cooperation and Engagement (NIICE), explained:

"The cause of depleting forex reserve is the high imports and huge trade deficit. Due to COVID-19, forex earnings from remittances and tourism have declined. However, the government has already taken the initiative of banning the imports of nonessential and luxurious goods, which can help in the saving of forex reserve. Due to the Russia-Ukraine crisis, Nepal has felt some inflationary pressure as Nepal is dependent on imports of petroleum products."

Sunil Chaudhary, Nepal Institute for International Cooperation and Engagement (NIICE)

Let's try to break all of this down one by one.

Tourism makes up for around 8 percent of Nepal's Gross Domestic Product (GDP). That sector took a hit, thanks to the COVID-19 pandemic.

This is one of the aspects that makes the crisis eerily similar to Sri Lanka's.

Tourism leads to an inflow of foreign currency, which hasn't been the case for the past two years since the pandemic started, wreaking havoc across the world.

In 2019, Nepal had 1.2 million tourists. That fell to 2,30,000 in 2020 and 1,50,000 in 2021, according to WION News.

Then there's the war between Russia and Ukraine.

Nepal's economy is dependent on imports (more than 40 percent of its consumption).

Energy is the key product. The invasion of Ukraine has spiked prices of oil and gas globally due to disruptions in the supply chain.

The Nepalese economy has begun to suffer as well because of the ripple effects of the war, as exemplified by the fuel prices mentioned above.

Additionally, the spike in price of oil and gas means that there is a greater outflow of foreign currency from Nepal (in order to purchase the commodities).

The flow of foreign remittances into the country has also reduced, which are basically non-commercial transfers of money by a foreign worker into the domestic country's household (like diaspora workers sending money back to their families).

Remittances make up around 25 percent of Nepal's GDP.

In this fiscal year, during the first eight months, remittances dropped by 1.7 percent, leading to a sharp drop in Nepal's reserves of foreign currency.

Domestic Turbulence

Nepal's domestic politics and how political institutions interact with each other will play a key role in the country's economic future.

"Political instability and political interference in institutions have some adverse effects on the Nepalese economy. Such as at the time of the crisis governor of the Nepal Rastra Bank was sacked by the finance minister. However, the supreme court of Nepal intervened and he was reappointed."

Sunil Chaudhary, Nepal Institute for International Cooperation and Engagement (NIICE)

The Himalayan Times, an English-language newspaper in Nepal, reported three weeks ago that the governor of Nepal Rastra Bank (NRB), Maha Prasad Adhikari, had been suspended.

The governor was accused of leaking information to the media regarding the finance ministry's recent decision to ban the import of luxury goods.

However, a report in The Kathmandu Post claimed, "Insiders say the sudden decision to suspend Adhikari comes on the heels of the news about Nepal Rastra Bank’s hesitancy in releasing Rs400 million transferred from abroad in the account of one Prithvi Bahadur Shah."

Can Nepal Save Itself?

There are reasons to believe that Nepal may not meet the same fate as Sri Lanka.

"Despite the contrary trends, Nepal’s economic situation is nowhere close to Sri Lanka’s scenario. It’s not too late for Nepal. Nepal should refrain from acquiring a huge loan for the unproductive sector and get caught into the debt trap that can challenge the Nepalese economy. Nepal has to reduce the unnecessary use of petroleum products and promote hydropower. There is also a need to strengthen economic diplomacy more effectively so that the development assistance from the developed country will not be affected."

Sunil Chaudhary, Nepal Institute for International Cooperation and Engagement (NIICE)

Additionally, Nepal does not rely on tourism as much as Sri Lanka, and the tourism sector in the former is starting to get back on its feet. The country even removed all pre-arrival mandatory testing for the fully vaccinated.

The second thing that is expected to increase is the inflow of foreign remittances into Nepal.

This is because, according to The Diplomat, Nepalese workers are beginning to, in large numbers, take approval for foreign employment and to renew their work permits abroad.

And thirdly, the debt to GDP ratio of Nepal is still less than half. Sri Lanka, in comparison, owed more than 60 percent of its GDP in 2020 (and an all-time high of 67 percent in December 2018).