By: Jeremy Weltman
Published on: Thursday, August 08, 2019
The country has climbed the most out of 186 countries in H1 2019, but investors must still treat the developing nation with extreme caution.
Famous perhaps only for playing partial host to the world’s highest mountain, Nepal has reached the summit in another respect lately by becoming the most improved country in Euromoney’s crowd-sourcing risk survey at the halfway mark this year.
Gaining more than five points to move 14 places higher in the global risk rankings since 2018, and a whopping 24 places during the past five years, the improvement seems nothing short of phenomenal.
It puts Nepal above the Maldives, Ethiopia, the Gambia and other nations in the top-10 most improved countries so far this year, according to economists and other risk experts that were polled:
Survey contributors have upgraded all 15 of Nepal’s political, economic and structural risk indicators this year, notably raising the score for government stability since the last legislative elections were held in 2017 and a solution was found to the political deadlock surrounding the senate electoral process delaying the government’s formation.
Chandan Sapkota, a senior fellow in economic research at the Nepal Economic Forum, is one of the survey analysts who says the rising country risk score is “primarily due to political stability, high economic growth for three consecutive years, low inflation and improvement in institutionalizing federalism”.
This latter issue helps to explain why the score for government finances has been upgraded, noting the fact financial assistance was recently approved by the World Bank to support the reforms required to accomplish an ambitious and gradual transition to a federal state.
Meanwhile, GDP has shown remarkable real-term strength during the past few years, growing by 7.9% in fiscal year 2016-2017 (to mid-July), and 6.3% in FY 2017-2018.
It has been bolstered by buoyant domestic demand leaning heavily on infrastructure investments, fuelled by China and India’s weighty foreign direct investments aiding the reconstruction effort after the earthquakes in 2015.
Downside risks include security disturbances by a fringe communist party, which has attacked private businesses and public assets - Chandan Sapkota, Nepal Economic Forum
Other multilateral creditors, including the Asian Development Bank and IMF, are predicting further strength, with GDP growth exceeding 6% in FY 2018-2019 and FY 2019-2020.
Again, this has been bolstered by high activity in construction, services – including tourism fuelled by an influx of Chinese visitors – and manufacturing, which is now less hindered since electricity outages have been resolved, enabling more capacity utilization.
Other notable developments, according to Sapkota, include “a stable government that has almost a two-thirds majority in parliament, progress in construction of major infrastructure projects, such as international airports and hydroelectricity, and amendments of major business-related regulations”.
These regulations include the Industrial Enterprises Act, Special Economic Zone Act, Public-Private Partnership and Investment Act, and Labour Act, among others, although, as they are yet to be implemented, it is impossible to gauge their effectiveness.
Nepal’s advancement must also be put into some context, with the country still mired within Euromoney’s highest-risk category, in 135th place, broadly equivalent to Madagascar, Belarus and Niger in risk terms, on a lowly score of just less than 32 from a maximum 100 points.
This is likely equivalent to a red-warning, junk-status credit rating were Nepal to ever receive one.
“Downside risks include security disturbances by a fringe communist party, which has attacked private businesses and public assets,” says Sapkota, highlighting the risks to business safety in a country where Maoist rebels are intent on violent left-wing extremism.
Deteriorating governance, especially fiduciary risks when it comes to implementing public projects, and the fact the fiscal deficit has increased under the weight of public spending – with additional outlays on poorly managed social security schemes – are also mentioned.
Meanwhile, inflation pressure has increased in response to an agricultural supply shock caused by flooding in the region, with the headline rate climbing above 5% in May.
“There is also the risk of a liquidity crunch in the banking sector as credit growth outpaces deposit growth, with deterioration in external sector balance – a widening current-account and balance-of-payments deficit and falling forex reserves,” adds Sapkota.
Invariably, strong domestic demand is drawing in vast quantities of imports of oil and other commodities, as well as consumer and capital goods.
This, of course, is partially driven by investments in future growth potential – a major tick mark – and it should not be overlooked that Nepal also receives substantial remittance income from its migrant workers counterbalancing its trade deficits.
Yet the relative lack of export competitiveness means the current-account deficit has widened disproportionately to 8% of GDP in FY 2017-2018, and is at risk of increasing further.
This is putting pressure on forex reserves that are still providing ample imports coverage, but cannot continue dwindling without jeopardizing equipment purchases for large projects, or undermining debt repayment capacity.
Nepal is this year’s early leader, it is becoming safer and is offering rare new opportunities to invest in higher-yielding assets.
However, as any Everest conqueror would firmly attest, the halfway mark means there is still a very long way to go, and more importantly you cannot ignore the risks.