What’s next for Nepal’s economy?

Locked between India and China, at the feet of the Himalaya, Nepal has historically been among the poorest and most remote countries in the world. After the end of the civil conflict in 2006, the country has embarked on a number of reforms and investments that have slowly improved the competitiveness of the country and reduced poverty. Nepal’s path to development was struck by the earthquakes that hit the country in April and May 2015. What will be the consequences of these events in the medium- and long-term? Will Nepal be able to recover and accelerate its path to prosperity?

In the last decade, the Nepalese economy achieved remarkable results in terms of poverty reduction, growth and competitiveness. Between 2005 and 2014, poverty rate in Nepal decreased from almost 80% of the population to 57%.

Historical data from the Global Competitiveness Report shows how Nepal’s competitiveness improved over the last decade, particularly in some of the more fundamental areas of competitiveness: education, infrastructure, macroeconomic environment, and institutions.

The country achieved some of the most significant improvements in the area of education. Primary enrolment rate increased from 79% in 2004 to 98% in 2013. Similarly, secondary enrolment increased from 46% to 76% and tertiary more than doubled from 6% to 14%. This is still low by international standards but higher than most other Least-Developed Countries (LDCs), in both Asia and, particularly, in Sub-Saharan Africa.

Infrastructure remains one of the main weaknesses of the country, although Nepal improved its performance especially in terms of access to electricity through hydro-electric generation. Given its landlocked nature and the orographic conditions of the territory, Nepal remains poorly connected to its neighbors and therefore cut out from access to the sea. This makes it extremely difficult for the country to join global value chains and build a manufacturing sector. Large parts of the country are still far from paved roads that allow connection throughout the year. The chart below compares the quality of transport infrastructure and seaport access in Nepal and other land-locked LDCs prior to the 2015 earthquakes. On both indicators, Nepal performed worse than Bhutan and of other peer countries. The two telluric events have further worsened the situation.

While posing serious problems for connectivity, Nepal’s mountainous nature could also be one of its main sources of prosperity, allowing for easy production of hydroelectric power. Nepal has invested particularly in Micro Hydroelectric Plants (MHPs) to provide access to electricity especially in the rural areas.

According to the World Bank there are 1’000 MHPs in the country, covering the needs of 20% of the population via off-grid electricity. Even though challenges remain, especially in connecting MHPs to the national grid and reducing the seasonality of the electricity supply, this is certainly a positive development as it provides clean and cheap energy also in remote areas. More investments are needed to scale up hydroelectric production and further reduce dependency on fossil fuels imported from abroad. A comparison with Bhutan shows clearly how hydroelectricity could do wonders in improving supply in the country and reduce foreign dependency.

Energy-dependence from abroad is also one of the factors that traditionally burdened Nepal’s current account, rebalanced thanks to the inflow of remittances from abroad. Nonetheless, macroeconomic stability has improved. Inflation remains high (at 9% in 2014), but public debt decreased from 52% of GDP in 2005 to 26% in 2014, with the government posting budget surpluses in both 2013 and 2014. Public finances and overall macroeconomic stability will be tested in the coming years, due to the post-earthquake recovery.

The World Bank estimates that the sum of direct damages and indirect losses for the Nepalese economy amount to 7 billion US dollars, corresponding to more than one third of the country’s GDP. With 750’000 houses and 7’000 schools destroyed or significantly damaged by the earthquake, about half of the total figure pertains to the social and housing sector. Transport and electricity infrastructure account for another 10% of total losses.

The World Bank also estimates that the earthquake will push 2.5-3.5% of the Nepalese population back into poverty. Growth projections for 2015 have been revised down from 4.6% to 3%. Losses in the tourism sector were particularly severe and will have a deep impact on the economy. The sector suffered 10% of all damages and losses and, accounting for 8.6% of Nepal’s GDP, represents a key source of wealth for the country. Tourist flows have significantly dropped after the earthquake even in sites that did not suffer significant damage.

Future years will tell us whether Nepal will be able to react without diverting from the path of stability and development it had slowly embarked on since 2006. The earthquake hit an extremely fragile economy, it further deteriorated the quality of infrastructure in the country and risks to put under stress an otherwise stable macroeconomic environment.

Most of reconstruction financing needs must come from external assistance, but Nepal has to find ways to improve its resilience in the future. Working with the private sector and other stakeholders within the country will be key to achieving this goal. The World Economic Forum Global Agenda Council on Risk & Resilience has published a report assessing innovations that the private sector can bring in working towards three goals: building resilience into houses, ensuring safe schools, and enabling tourism. In the words of the report: “The extent and complexity of the natural risks Nepal faces mean that a multistakeholder approach to resilience is vital.”

The report, Building Resilience in Nepal Through Public-Private Partnerships is available here

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Author: Attilio Di Battista is a Quantitative Economist on the Global Competitiveness and Risks team at the World Economic Forum.

Image: A woman (C) buys vegetables along the streets of Kathmandu, Nepal October 6, 2015. REUTERS/Navesh Chitrakar