Should pivot the Second Phase of Economic Reforms
The budget for the upcoming Fiscal Year 2026/27 should focus on economic reform. This is an opportune moment, as the first phase of economic reform in Nepal took place in the early 1990s but lasted only a few years. There has been a sore lack of ‘big push’ reforms over the last three decades, and the economy is currently in a state of decline. I personally believe there are two ways to move the economy forward: first is governance reform, and second is economic reform.
The incumbent government, immediately after assuming office, launched a 100-point programme for governance reform, setting a very strong and positive initiative. Governance reforms comprise procedural, legal, regulatory, and institutional reforms. These must improve the ease of doing business to create momentum in the economy.
While governance reforms are necessary conditions for the economy to gain traction, they alone are not sufficient. If we wish for the economy to progress, the government should not limit itself to governance reforms. The incumbent government is powerful enough to initiate and execute a second generation of economic reform starting with its first budget. Had the government announced critical second-generation reform initiatives even before the budget, it would have prompted a ‘big push’ in the currently stagnant economy.
The first budget of the new government is being unveiled on May 29, two months after the government’s formation, providing sufficient time for preparation. Second-generation economic reform must be backed by strong pillars, with capital account convertibility and exchange rate flexibility at the heart of these efforts. This is an opportune moment, not only from a political perspective but also due to historically high foreign exchange reserves, which are currently sufficient to cover 18.5 months of goods and services imports. Executing initiatives like the government’s 100-point governance reform programme is a prerequisite for achieving capital account convertibility and exchange rate flexibility. Based on a study I conducted for the National Planning Commission a few years ago, a crawling exchange rate flexibility mechanism could be introduced within a defined band for the initial few years to allow the market to gradually adjust and prepare. By introducing elements of flexibility, such as a band or a basket, the government can transition to full-fledged flexibility within the next three to four years.
The three pillars of the first phase of economic reform in the 1990s were liberalisation, privatisation, and globalisation (LPG). These sought to enable the effective functioning of market forces based on the laws of demand and supply, opening the economy to private sector investment in areas such as civil aviation, banking, hydropower, and telecommunications. Furthermore, these reforms aimed to end the ‘License Raj’ regarding internal economic activities and international trade.
The results of this first phase were mixed due to limitations in institutional reform. While it allowed the private sector to grow and thrive, Nepal failed to fully capitalise on the benefits of globalisation. Additionally, there were complications regarding the outcomes of privatisation. These experiences should serve as vital lessons for the second phase of economic reforms.
For the second generation of economic reforms to be results-driven, strong institutions must be in place. The 2008 financial crisis exposed economic vulnerabilities and highlighted the urgent need to deepen reforms upon a solid institutional foundation. A critical global lesson from that crisis is that market forces cannot function effectively unless the supporting institutions are robust.
Against this backdrop, institutional strengthening should be the top priority of second-generation reforms. The independence and accountability of regulatory agencies must go hand in hand. From this perspective, strengthening institutions is key to sustaining reform initiatives and leveraging their optimal benefits.
There are two types of institutions: regulatory and operating. Key regulatory agencies in Nepal include the Nepal Rastra Bank, Securities Board of Nepal, Nepal Insurance Authority, Civil Aviation Authority of Nepal, Nepal Telecommunications Authority, and Nepal Electricity Regulatory Commission, among others. Strengthening these agencies opens new avenues and minimises the risks associated with weak regulation. For instance, improving aviation oversight could enable Nepal’s national flag carrier to fly to Europe by allowing the European Union to lift its current ban.
Operating agencies, such as commercial and development banks, should avoid crises and minimise impacts by implementing international best practices. Adopting risk-based regulatory and supervisory provisions is essential for the successful transition toward capital account convertibility and exchange rate flexibility.
Another critical issue the budget should incorporate is public sector efficiency, specifically regarding institutions under the federal government and state-owned enterprises (SOEs). If the public sector is inefficient, it creates backlashes for private sector development and hinders growth, making it Herculean to generate economic momentum.
Most importantly, the budget should prioritise developing an Industrial Development Strategy. While the first phase of economic reform emphasised trade facilitation, scrapped the License Raj, and introduced Open General Licensing (OGL), it failed to make industrialisation a major priority. Since those first-generation reforms, Nepal has not formulated a formal or trustworthy industrial strategy. Instead, various versions of the Nepal Trade Integration Strategy have dominated the trade and development domain. The new budget should provide a roadmap for industrial sector development to create economic momentum, improve international trade competitiveness, and enable the economy to leverage various government policies.
Moreover, although the country has practiced fiscal federalism since the promulgation of the new constitution, ambiguity remains regarding federal industrial administration. An Industrial Development Strategy should provide a roadmap for this, focusing on prerequisite infrastructure development. Subnational governments are also awaiting a roadmap or feedback from the federal government regarding industrial development, which is not clearly outlined in the Local Government Operation Act (2017) or other relevant laws. The roadmap provided by such a strategy would pave the way to amend the Local Government Operation Act and the Industrial Enterprises Act as envisioned.
Furthermore, the government should develop the necessary institutions and infrastructure to support industrial development. At least seven large-scale industrial zones should be moved toward execution. The announced sites, including Daiji in Kanchanpur, Naubasta in Banke, Laxmipur in Dang, Motipur in Rupandehi, Shaktikhor in Chitwan, and Mayurdhap in Hetauda, must be implemented. Immediate steps, such as site clearance, providing electricity access, and rehabilitating squatters, should be initiated through specific budget allocations.
Moreover, Special Economic Zones (SEZs) must also be developed. The development of SEZs has struggled to gather pace, partly due to the need to clearly define and consolidate the roles of SEZs and Industrial District Management Limited (IDML) to streamline industrial estates. Addressing this is crucial for creating economic momentum and fostering a robust private sector. Otherwise, Nepal will remain dependent on imports due to the lack of a competitive domestic production base.
Nepal must also identify its position on the ‘SMILE curve’ of industrial development – whether it focuses on processing industrial raw materials, establishing assembly plants, developing sophisticated products, or packaging. This prioritisation will define Nepal’s place within the industrial value chain.
In a nutshell, these efforts will define the roles of different government tiers in industrial administration while streamlining both institutions and infrastructure.
Moreover, the upcoming budget must direct export diversification. Nepal must pay attention to the selection, feasibility, and future of potential export products while considering our limitations, such as being landlocked and facing high logistics costs, since bulky, high-volume products are less scalable. Instead, we should focus on services and products that can be scaled effectively, such as professional services and Business Process Outsourcing (BPO). To open investment in professional services, including management, engineering, accounting, auditing, and legal consultancy, Nepal needs to amend the Foreign Investment and Technology Transfer Act (FITTA).
Amending the ‘negative list’ in the FITTA annexes would open the door for the ‘Big Four’ firms: Deloitte, PwC, Ernst & Young, and KPMG. These firms could bring back-office work related to education, health, financial services, and water supply from developed countries, revolutionising employment opportunities and export volumes. Providing gainful employment to Nepal’s educated youth and talent would allow the country to achieve a $100 billion economy in the next few years, following the path of vibrant BPO hubs in India like Bengaluru, Hyderabad, and Chennai.
The final element to be incorporated into the heart of the second-generation economic reforms in the Fiscal Year 2026/27 budget is financial sector reform. The Nepal Rastra Bank (NRB) must be strengthened as a professional, independent, and accountable central bank through an amendment to the NRB Act. Furthermore, the Bank and Financial Institutions Act (BAFIA), which is currently being amended, requires further work to address excess liquidity challenges. This includes establishing a clear segregation between bankers and businesspersons, introducing digital banks, and adding provisions for provincial and local development banks to restructure the sector. Restructuring should focus on three areas: transitioning from traditional to digital banking; segregating bankers and businesspersons to aid capital formation and credit expansion; and licensing provincial and local development banks for greater financial deepening.
In a nutshell, Nepal must quash barriers to inward inflows. For example, restrictions on Foreign Direct Investment (FDI) in the agriculture and services sectors must be addressed, and mandatory joint venture provisions for FDI in other sectors should be removed. The upcoming fiscal budget should spell out a timed action plan for the implementation of the reforms announced for 2026/27.
Thapa is former Executive Director of Nepal Rastra Bank.
