The 3% trap IMAGE: ASHISH KOIRALA
For a brief moment last year it seemed Nepal had found its footing. After two years of contraction, the country’s manufacturing and construction sectors rebounded. The turbines of new hydropower projects spun furiously, adding over 700 megawatts to the national grid, a leap of nearly 23% in capacity. Farmers, blessed by a timely monsoon, brought in a bumper harvest of paddy, helping to cool inflation to a manageable 4.1%. By the time the fiscal year ended in mid-2025, the economy had grown by 4.6%. The mood in Kathmandu, usually as hazy as the city’s winter air, began to clear.
That optimism now looks premature. As Nepal enters 2026 the momentum of the past year is dissipating. The Asian Development Bank projects growth will slip to 3.0%, and even that meager figure relies on assumptions that look increasingly fragile. The economy is being squeezed by a pincer movement of bad weather and bad politics, ripping open the country’s decaying foundations that a surge in electricity exports cannot paper over.
The trouble begins, as it usually does in the Himalayas, with the skies. Agriculture still accounts for a third of the economy and employs the bulk of the population. Last year’s golden harvest has given way to this year’s mud. A delayed monsoon in the Madhesh province, the country’s breadbasket, was followed by devastating floods in October. The result is a sharp plunge in paddy output that threatens to push food inflation back toward the central bank’s 5% ceiling. When farm incomes fall, rural consumption—the engine of the economy—sputters.
Yet the slowdown is not merely a matter of meteorology. The industrial sector, which grew by 4.5% last year, is projected to slow to 4.0%, and manufacturing specifically is expected to crawl at just 1.7%. The culprit here is man-made. Political instability has returned to the streets, rattling business confidence. In a cruel irony, while the country has more electricity than ever, factories are being idled not by load-shedding, but by civil unrest and a lack of demand. The construction sector, a bellwether for the wider economy, is languishing. In the first four months of the current fiscal year, the government managed to spend less than 6% of its capital budget. This chronic inability to build roads and bridges, even when funds are available, has become a hallmark of governance.
The services sector is feeling the chill, too. Growth there is expected to slide from 4.2% to 3.1%. Although tourist arrivals ticked up in October, occupancy rates in hotels are down, spooked by the images of protesters in September. Financial services are also straining under the weight of the unrest: claims related to property damage during protests are estimated at 0.4% of GDP. This comes at a time when the banking sector is already cautious with loan performance wobbling.
Fiscal discipline meanwhile is slipping. The government faces the expensive distraction of upcoming elections. Recurrent spending is set to yank up as politicians loosen the purse strings to woo voters, forcing a hike in defence spending due to security headaches. This crowds out the investment needed to fix the country’s creaking infrastructure. The fiscal deficit, which had narrowed to 2.0% of GDP in 2025, is expected to widen to 3%. Revenue collection is already faltering, down 6.4% year on year in the first two months of the fiscal cycle.
If the domestic picture is gloomy, the external sector provides a strange cocktail of relief and risk. Nepal’s lifeline is its diaspora. Remittances surged by over 16% last year, striking a staggering 25% of GDP. These inflows cushion the trade deficit and have helped build foreign exchange reserves of $21bnbn, enough to cover more than 16 months of imports. This flood of cash allows the government to run deficits and consumers to buy imported goods, from mobile phones and booze to passenger vehicles, without precipitating a balance-of-payments crisis.
But that reliance on exported labour is a precarious safety net. Geopolitical tensions in the Middle East, where legions of Nepalis work, pose a constant threat to these flows. Furthermore the “Dutch disease” effect of high remittances has left domestic industries uncompetitive. Merchandise exports did jump nearly 65% last year, but the main driver was soybean oil, a commodity Nepal does not produce but imports, refines and re-exports to India to exploit tariff differentials under the South Asian Free Trade Area (SAFTA) agreement. Such regulatory arbitrage is hardly the stuff of a sustainable industrial strategy.
The government has touted an Economic Revival Plan, promising tax relief and financing support to kickstart growth. However, without a fix for the paralyzed capital spending mechanism, such measures are likely to be little more than a sticking plaster. The Asian Development Bank is stepping in with support for digitalisation and reform, hoping to drag the state bureaucracy into the 21st century, but these are long-term projects in a country that lives strictly in the short term.
Nepal enters 2026 with its two most promising engines—hydropower and tourism—still running, but facing headwinds. The electricity subsector, despite flood damage knocking 180mw offline, remains a rare bright spot of genuine productivity. Yet you cannot eat megawatts. Unless the government can quell the political volatility and learn how to spend its own budget, the economy will stay trapped in a cycle of low growth and high dependency. Investment bankers in Kathmandu might find the coming year quiet, but for the politicians, the sleepless nights are just beginning. ■
