US embassy cable - 02KATHMANDU892

UNCLAS SECTION 01 OF 02 KATHMANDU 000892 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR SA/INS 
NSC FOR HARRY THOMAS 
LONDON FOR POL - RIEDEL 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, ETRD, PGOV, NP, Maoist Insurgency 
SUBJECT: NEPAL'S ECONOMIC GROWTH:  ANOTHER CASUALTY OF THE 
INSURGENCY 
 
 
--------- 
SUMMARY 
---------- 
 
1.  (SBU)  The economy of Nepal, already one of the poorest 
countries in the world, is in crisis, struggling under the 
combined squeeze of escalating expenditures, primarily 
related to the six-year-old Maoist insurgency, and plummeting 
revenues.  Government development funds are already being 
diverted to cover some of these costs.  Finance Ministry 
officials expect the cash crunch to worsen in the coming 
fiscal year, which begins July 15.  Absent an appreciable 
improvement in the security situation, economic conditions 
will continue to decline.  End summary. 
 
--------------------- 
THE POOR GET POORER 
--------------------- 
 
2.  (U) Nepal is one of the poorest countries in the world 
with a per capita income of just over USD 240.  About 40 
percent of the population lives below the poverty line.  A 
population growth rate of 2.4 percent has outpaced the 
economy's ability to create jobs; underemployment is 
estimated at nearly 50 percent.  While economic reforms since 
1991 have helped maintain postive GDP growth, for the past 
two years the growth rate has been lower than expected, 
largely because of the depressed business climate and 
off-budget government expenditures related to the Maoist 
insurgency. 
 
------------- 
FISCAL FEARS 
------------- 
 
3.  (SBU)  The final quarter of the current fiscal year, 
which ends July 15, is especially gloomy, complicated by 
simultaneously skyrocketing expenditures and plunging 
revenues.  Security expenditures alone, fueled by the 
unforeseen cost of deploying the army under the state of 
emergency declared in the second quarter, have already 
surpassed the budgeted amount by at least 30 percent in the 
current fiscal year, forcing the Government of Nepal (GON) to 
introduce a supplemental budget in the upcoming session of 
Parliament.  In the next year, defense spending may account 
for as much as 25 percent of the budget (as compared to 14 
percent during the current year), according to Finance 
Secretary Bimal Prasad Koirala.  While requests from the 
 
SIPDIS 
army, police, and Armed Police Force for big-ticket equipment 
items, such as helicopters, may account for much of the jump, 
training, recruitment (the Army alone plans a 10 percent hike 
in recruitment), and deployment costs for the 50,000-man Army 
have also eaten into the budget. 
 
4.  (U)  At the same time that expenditures are mounting, 
revenues are in a tailspin.  Nepal's FY 02 budget assumed a 
20 percent increase in national revenue; growth, instead, has 
been only a fifth of that.  Garments, Nepal's largest 
manufactured export, are down by more than 50 percent for the 
year, a drop prompted primarily by declining orders from the 
U.S., which accounts for 85 percent of Nepal's garment 
market.  Carpet exports, meanwhile, registered a 27 percent 
decline compared with the previous year, while pashmina 
shawls, Nepal's largest handicraft export, dipped by 70 
percent.  The deteriorating security situation has depressed 
Nepal's generally lucrative tourism sector, which last year 
accounted for more than 4 percent of GDP and contributed more 
than 15 percent to Nepal's forex earnings.  In the month of 
April alone, arrivals plummeted by 50 percent compared with 
the previous year.  According to the Central Bureau of 
Statistics, the hotel/tourism/restaurant industry this year 
for the first time registered negative growth--a dismal -5 
percent.  Revisions to the bilateral trade treaty with India, 
Nepal's largest trading partner, may further depress exports 
by an additional 10 percent next year, Koirala predicted. 
 
5.  (SBU)  Despite the decline in revenues, Finance Secretary 
Koirala said he believes the GON "can manage" for the rest of 
the FY.  He fears that may not be the case in the coming 
fiscal year, when revenues may not cover regular 
expenditures, and the GON may be unable to come up with the 
20 percent needed in counterpart funding to keep many foreign 
donor programs going.  He morosely confided to econoff that 
his Ministry has "no idea" where it will find the funds 
necessary to meet mounting expenditures for the next year. 
Other Ministry sources estimate that the budget deficit, 
which typically hovers between 5-6 percent, will jump to 10 
percent.  The GON will try to meet the shortfall through 
internal borrowing--which is limited to 2 percent of GDP--and 
through the munificence of foreign donors. 
 
---------------------------- 
GROWTH PROJECTIONS GLOOMY 
---------------------------- 
 
6.  (U)  Given the dismal outlook, the Ministry of Finance 
has revised GDP growth projections for the current year from 
6 percent to a more modest 2 percent--the slowest rate 
registered since the restoration of democracy in 1992.  On 
May 6, the Central Bureau of Statistics (CBS) released 
figures projecting even more somber numbers--0.76 
percent--the lowest growth rate in nearly 20 years.  Bad 
weather kept growth in the agricultural sector, which 
accounts for about 40 percent of GDP, to only 1.7 percent, 
while non-agricultural growth registered a disappointing .15 
percent. 
 
----------------------- 
DEVELOPMENT SUFFERS 
----------------------- 
 
7.  (SBU)  The GON's budget woes are affecting implementation 
of development projects, as funds targeted for development 
are shifted to compensate for the 10 percent increase in 
regular expenditures.  So far, however, the GON has managed 
to keep up payment of critical counterpart funds for donors' 
projects by cutting its own development programs.  For 
example, development funds allocated to Village Development 
Councils have been cut by 50 percent this year, while those 
for District Development Councils have shrunk by 25 percent. 
Altogether 30 percent of the current year's development 
budget will not be met, according to Finance Secretary 
Koirala; in the upcoming fiscal year, there may be no 
development resources at all for local bodies provided by the 
GON.  The increasingly violent insurgency has, moreover, 
exacted an additional toll, Koirala lamented.  Besides the 
cut in the development budget, the GON must also find a way 
to pay more than USD 104 million in unbudgeted repair costs 
to infrastructure damaged in Maoist attacks over the past 
five months. 
 
--------- 
COMMENT 
--------- 
 
8.  (SBU) While the GON may be legitimately criticized for 
some fiscal imprudence in the past, the primary factors 
undercutting economic performance this year--an unprecedented 
state of emergency and military mobilization; fall-out from 
September 11 on the tourism industry; a downturn in the 
economies of Nepal's major export markets--were well beyond 
both the control and the foresight of budget planners. 
Unfortunately, absent an appreciable improvement in the 
security situation, many of the factors aggravating the 
current cash crunch are likely to get worse instead of better 
in the near term.  We expect both the frequency and the 
urgency of Nepal's pleas for assistance to the donor 
community to increase in the coming months. 
 
 
 
MALINOWSKI