Navigating Nepal's Economic Turmoil: A Call for Strategic Reform

Nepal’s economy today stands at a delicate crossroads, entangled in a web of internal inefficiencies and external shocks. The aftermath of the pandemic, coupled with weak financial governance, skewed credit flows, and underperforming institutions, has left the economic foundation shaky and uneven.

One of the most critical threats has emerged from poor oversight in key financial sectors such as microfinance and cooperatives. Their growing instability is no longer isolated — it’s rippling through the wider financial system, threatening long-term macroeconomic health.

Overreliance on Monetary Tools, While Ignoring Broader Policy Mix

While global economies responded to COVID-19 with synchronized fiscal and monetary action, Nepal leaned disproportionately on monetary policies. This narrow approach has fallen short of energizing economic recovery. A more balanced framework — blending fiscal discipline, industrial strategy, and institutional reform — is essential.

Global Headwinds Amplify Nepal’s Vulnerability

In a world increasingly shaped by climate chaos, geopolitical conflict, and mounting defense expenditures, aid and investment for developing countries are shrinking. As a highly import-dependent economy, Nepal is feeling these pressures acutely.

Defense spending globally surged to $2.7 trillion in 2024, according to SIPRI. Consequently, sectors like health, education, and infrastructure are losing out on vital funding — a trend that is already reshaping development priorities and reducing aid flows to countries like Nepal.

Declining Foreign Aid and Rising Debt Risks

Recent global trends show a clear shift: international grants are declining while loan-based assistance is rising. This shift places fragile economies under heavier repayment obligations, draining funds from critical development needs.

Nepal is no exception. More than 49% of its GDP is now tied up in public debt, and over one-fifth of the national budget is allocated just for loan repayments. As grants dry up, Nepal must become more strategic about external borrowing and double down on improving domestic revenue systems.

Geopolitical Instability and Trade Frictions

Global trade instability — fueled by conflicts like the U.S.–China trade war and regional rivalries — is narrowing export windows for developing countries. Nepal, with its already limited export base, is facing pressure from currency devaluation, volatile investment flows, and growing import costs.

The IMF’s forecast of a modest 2.8% global growth rate in 2025 implies reduced demand and tighter financial conditions — both of which pose serious risks for Nepal’s external sector.

Climate Change: A Slow-Burning Financial Threat

Nepal is also on the front lines of climate risk. Annual GDP losses from climate-related impacts are estimated between 1.5% to 2%, and could reach 3% by 2050. Disrupted agriculture, damaged infrastructure, and recurring natural disasters are imposing a mounting fiscal burden.

Without targeted climate adaptation strategies and access to climate financing, both public and private investments may continue to stall.

Regional Setbacks and Missed Opportunities

South Asia’s regional trade remains dismally low, largely due to political mistrust and lack of integration — especially between India and Pakistan. Nepal has not been able to leverage regional supply chains or infrastructure partnerships, leaving significant economic potential untapped.

By contrast, Southeast Asia enjoys over 25% intra-regional trade, highlighting what coordinated policy and shared infrastructure can achieve.

Structural Barriers and Budgeting Deficiencies

Nepal’s budget-making process still follows outdated conventions. The country lacks the kind of outcome-based budgeting embraced by countries like New Zealand, where accountability, efficiency, and policy alignment are central.

Moreover, a disproportionate share of Nepal’s budget is consumed by recurrent spending — leaving little room for development investment. Infrastructure, innovation, and productivity continue to lag, especially in high-potential sectors like agriculture, tourism, and energy.

Financial Sector Woes and Weak Regulation

Nepal’s banking sector is under pressure from rising non-performing loans and opaque financial practices. The FATF’s decision to place Nepal on the “grey list” reflects serious gaps in regulatory enforcement, particularly in cross-border remittances, real estate finance, and unusual transactions.

Without robust surveillance systems and strengthened regulatory capacity at the central bank, investor confidence and global financial integration will remain at risk.

Federalism and the Challenge of Fiscal Coordination

As fiscal federalism unfolds in Nepal, the imbalance in resource distribution among federal, provincial, and local levels has raised concerns. With central revenues falling, the autonomy of sub-national governments is under threat — potentially undermining the entire federal model.

The Way Forward: Strategic and Systemic Reform

To navigate this economic complexity, Nepal must embrace comprehensive reform:

• Policy Synergy: Align monetary, fiscal, and industrial policies to maximize their combined effect.

• Outcome-Oriented Budgeting: Shift to a results-driven budget framework, prioritizing transparency and accountability.

• Private Sector Mobilization: Create policies that encourage both domestic and foreign investment.

• Institutional Strengthening: Enhance regulatory efficiency and fully implement FATF standards through automated monitoring systems.

• Climate Finance Access: Aggressively pursue international climate funds for adaptation and mitigation efforts.

• Federal Financial Framework: Clearly define responsibilities, improve coordination, and enforce fiscal discipline across all levels of government.

Nepal’s economic path forward will require more than incremental fixes. It demands a deep restructuring of financial systems, governance practices, and development strategies. Reducing external dependency, enhancing productivity, and boosting institutional capacity are the cornerstones of a resilient and inclusive economic recovery.