Record Foreign Exchange Reserves Give Nepal a Strong Cushion, but Raise Questions Over Weak Investment

Kathmandu — Nepal’s foreign exchange reserves and remittance inflows have climbed to their highest levels on record, strengthening the country’s ability to finance imports and withstand external economic shocks. The figures, however, also point to sluggish domestic investment, weak capital expenditure and limited demand for productive imports.

According to the latest figures released by Nepal Rastra Bank, the country’s gross foreign exchange reserves increased by 40.3 percent to Rs 3.76 trillion by the end of Jestha 2083. The reserves had stood at Rs 2.68 trillion at the end of the previous fiscal year.

In absolute terms, Nepal added nearly Rs 1.08 trillion to its foreign currency holdings within the first 11 months of the fiscal year. Such a large increase provides the country with a substantial external financial buffer, particularly at a time when global fuel prices, geopolitical tensions and exchange-rate movements remain uncertain.

In US dollar terms, the reserves increased from $19.50 billion to $24.68 billion, representing growth of 26.5 percent. The difference between the growth rates measured in rupees and US dollars is likely to reflect exchange-rate and valuation effects, including changes in the value of the Nepali currency against major international currencies.

Of the total reserves, Rs 3.33 trillion was held by Nepal Rastra Bank. This was 37.9 percent higher than the Rs 2.41 trillion maintained by the central bank at the end of the previous fiscal year.

Commercial banks and other financial institutions held an additional Rs 425.57 billion in foreign currency reserves. Their holdings increased by 61.8 percent from Rs 263.04 billion.

The figures show that Nepal Rastra Bank controlled nearly 88.7 percent of the country’s total foreign exchange reserves, while banks and financial institutions held the remaining 11.3 percent. The high concentration of reserves at the central bank gives the monetary authority significant capacity to manage external payments and maintain stability in the foreign exchange market.

Indian currency accounted for 21.5 percent of the total reserves. This remains important for Nepal because India is the country’s largest trading partner and a substantial share of cross-border transactions is settled in Indian rupees.

Based on the import pattern recorded during the first 11 months of the fiscal year, the available reserves are sufficient to finance merchandise imports for 22.5 months. They can cover imports of both goods and services for 19.1 months.

This is an exceptionally comfortable level of import coverage for an import-dependent economy. It means Nepal has enough foreign currency to pay for fuel, medicine, machinery, food, industrial materials and other essential imports for more than a year and a half, even in the absence of fresh foreign currency inflows.

The reserves were equivalent to 61.5 percent of the country’s gross domestic product. They were also equivalent to 159.5 percent of total imports and 43.7 percent of broad money supply.

At the end of the previous fiscal year, the corresponding ratios were 43.8 percent of GDP, 128.1 percent of imports and 34.1 percent of broad money supply. The reserve-to-GDP ratio therefore increased by 17.7 percentage points, while the reserve-to-import ratio rose by 31.4 percentage points.

The rapid rise in reserves has been supported mainly by a surge in remittance inflows. Remittances increased by 38.2 percent to more than Rs 2.12 trillion during the review period.

The strong inflow reflects the continuing expansion of Nepal’s overseas labour economy. A large number of Nepali workers remain employed abroad, and improvements in formal banking channels may also have helped bring a larger share of their earnings into the recorded financial system.

For families receiving the money, remittances remain an important source of income for food, education, healthcare, housing and loan repayment. At the national level, they have become the principal source of foreign currency and a major support for the balance of payments.

The latest data demonstrate how heavily Nepal’s external stability depends on money earned by workers abroad. Remittances are helping finance imports and build reserves, but the same trend highlights the economy’s limited ability to earn foreign currency through exports, industrial production, tourism and high-value services.

Reserve accumulation has also been supported by restrained foreign currency spending. Imports have not expanded at the same pace as remittances, while the government has struggled to carry out development expenditure.

Capital expenditure declined by 7.5 percent compared with the corresponding period of the previous year. Weak capital spending generally means delays in roads, transmission lines, irrigation systems, airports, public buildings and other development projects.

Many large infrastructure projects require imported machinery, electrical equipment, construction materials and technical services. When such projects are delayed, the demand for foreign currency also remains low, allowing reserves to accumulate at the central bank.

The rise in foreign exchange reserves must therefore be interpreted from two sides. It is a sign of external strength because Nepal is better prepared to meet international payment obligations. At the same time, it may indicate that the economy is not investing enough in activities that require productive imports.

The composition of imports also raises questions about the quality of domestic economic activity. Imports of transport equipment and petroleum products have increased, while imports of some raw materials have declined.

A fall in raw-material imports can indicate weaker industrial activity because factories generally import inputs before increasing production. By contrast, higher spending on vehicles, petroleum products and consumption-related goods may raise foreign currency expenditure without creating a comparable increase in domestic productive capacity.

High reserves reduce the immediate risk of a balance-of-payments crisis. They provide assurance that the country can continue importing essential goods even during a sudden fall in remittances, tourism earnings or export revenue.

They also strengthen Nepal Rastra Bank’s ability to maintain confidence in the exchange-rate system, meet foreign debt payments and respond to external disruptions. For an economy affected by geographical constraints and dependent on imported energy and industrial materials, such protection is particularly valuable.

However, foreign exchange reserves should not be viewed as money that can be spent freely by the government. They are external assets maintained to meet foreign currency liabilities and international payment requirements.

The central bank generally invests part of the reserves in safe and liquid foreign assets, such as deposits and government securities. Such investments earn returns and allow the funds to be accessed when needed, but the returns are usually lower than those potentially generated by productive domestic projects.

Using the reserves productively does not mean transferring them directly into the government’s domestic budget. A more practical approach would be to develop viable infrastructure and industrial projects that use foreign currency to import capital equipment while creating future production, exports and employment.

Investment in hydropower, electricity transmission, irrigation, tourism infrastructure, information technology and manufacturing could gradually absorb part of the reserves through productive imports. Such spending may reduce the immediate reserve stock, but it could strengthen the economy’s long-term capacity to generate income.

Large infrastructure projects would also create domestic demand for labour, construction materials and supporting services. The challenge is to ensure that foreign currency is used for assets that raise productivity rather than for short-lived consumption.

The sharp growth in remittances has also revived the debate over how migrant income can be channelled into investment. Most remittances are sent directly to households, meaning the government cannot determine how the funds are spent.

Public policy can nevertheless create better investment opportunities for remittance-receiving families. Local and provincial governments could identify commercially viable activities suited to their areas and provide training, market access, technical assistance and basic infrastructure.

Financial institutions could also develop transparent savings and investment products linked to productive sectors. Migrant workers and their families are more likely to invest when projects offer credible management, understandable risks and dependable returns.

The authorities must also avoid treating the current reserve position as permanently secure. Nepal’s remittance income depends on employment conditions in destination countries, international migration policies, oil-producing economies and global demand for labour.

A slowdown in major labour markets or a fall in the number of workers going abroad could weaken remittance growth. A rapid increase in imports or the implementation of several large infrastructure projects could also reduce the reserve stock.

For now, Nepal’s external sector is in a highly comfortable position. The country has substantial capacity to finance imports, manage external obligations and absorb short-term economic shocks.

The deeper concern is whether the reserve accumulation reflects genuine economic strength or an economy that is saving foreign currency because it lacks sufficient investment and production. The answer appears to contain elements of both.

Strong remittances have protected Nepal from external instability, but weak capital expenditure and subdued productive imports suggest that domestic economic momentum remains limited. The policy priority should therefore be to preserve an adequate reserve buffer while converting a portion of the country’s external comfort into productive investment, employment and sustainable sources of foreign currency income.

BBC Nepali