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
SUBJECT: NEPAL'S ECONOMIC GROWTH: ANOTHER CASUALTY OF THE
INSURGENCY


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SUMMARY
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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.

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THE POOR GET POORER
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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.

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FISCAL FEARS
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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.

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GROWTH PROJECTIONS GLOOMY
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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.

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DEVELOPMENT SUFFERS
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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.

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COMMENT
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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