Ukraine crisis hits Nepal economy hard

On 8 March, international crude oil prices hit a record $139 per barrel due to the Ukraine crisis — nearly double the value last year.

The longer the war drags on and sanctions tighten, the higher the prices are expected to go, with a domino effect on economies around the world, including Nepal.

Being the world’s second largest producer of oil, Russia’s inability to export petroleum products has created a big gap in supply. Europe’s reliance on Russian gas has also made the Ukraine conflict a ‘fossil fuel war’.

Nepalis are now paying Rs150 for every litre of petrol and Rs133 for diesel and kerosene at filling stations. And the graph is still going up.

The state-owned Nepal Oil Corporation (NOC) is losing Rs16 for every litre of petrol and Rs12 for diesel it sells, raking up losses of Rs5 billion every month, which means further price hikes are a certainty.

What’s more, Nepal is yet to be hit with the full impact of increasing oil prices internationally. The Indian Oil Corporation, which sets a new price for petroleum every 15 days, adding processing, administrative and other charges, is yet to set a new price tag to NOC. India is expected to hike fuel prices after last week’s state elections.

“Frankly, we are scared to even estimate our next month’s loss,” says Sushil Bhattarai of the NOC, which has already incurred Rs28 billion in losses in the past six months against last year’s import bill of Rs132 billion.

The longer the Russo-Ukraine war drags on, supply bottlenecks will remain leading to rising prices at the filling stations. At this rate, the NOC will be unable to pay its bills on its own, and will have no recourse but to further increase the price of petroleum.

The government is already under pressure to manage funds for upcoming elections with limited revenue as a result of recent policies aimed at discouraging imports. The NOC is therefore unlikely to be able to dip into foreign exchange reserves to foot the bill.

But the hike does not only apply to petroleum. Every hike in the price of fossil fuel has a knock on effect on the cost of production and transportation. This means consumers have to pay more for all goods from food to gold, and everything in between.

Coal, which cost $67 a tonne until a year ago is now at $400. Iron ore was priced at less than $100 per tonne last November, but is now $160 a tonne. A tonne of soybean costs $1,800, up from $1,150. Wheat prices have gone up by 45% in the past month.

Petroleum products make up 13% of Nepal’s total imports. Next in the list of high imports are iron and iron products and food grain. In the first six months of this fiscal year, Nepal spent about Rs58 billion on iron and iron goods, Rs77 billion on vehicles and spare parts, Rs64 billion on soybean and palm oil, Rs23 billion on gold and Rs17 billion on coal.

As the price of these commodities increase in the international market, Nepal has to dig into its foreign currency reserves to pay for imports.

Another notable impact of the Ukraine conflict is on currency depreciation. The exchange rate of the Nepali rupee against a US dollar dropped to a new record depreciation of Rs123.44.

Although this means remittance sent by Nepalis abroad will increase in rupee terms, as will the competitiveness of Nepali goods abroad, we are unlikely to benefit because Nepal does not have much to export.

Alternatively, as the value of the dollar rises, so does the Nepal’s debt burden, putting additional burden on the state exchequer.

To be sure, even before the Russia-Ukraine war, inflation was at a record high. In fact, the prices of crude oil, metals, food grains and other intermediate commodities have increased sharply in recent years.

Moreover, increased demand for goods in countries that had just recovered from Covid-induced recession is leading to supply chain disruptions and a further increase in prices.

The war is just adding fuel to the fire, and as result the prices of all essential goods have skyrocketed. Traders and local businesses are also using the crisis to their full benefit.

"Our market is not competitive as it is and weak regulation means traders set new prices indiscriminately on the pretext of the international price hike," says economist Dadhi Adhikari.

For example, soybean oil, which cost Rs120 per litre last year, is now priced at Rs255. Sunflower oil is Rs280 per litre, having seen an increase of Rs40 for a litre.

“Prices of most consumer goods in the past month have gone up by 15-20%. When the international market has seen price hike of 30% on average, it is sure to affect our market too,” says Subodh Kumar Gupta of the Association of Nepalese Rice, Oil & Pulses Industry.

This price hike also applies to poultry and eggs even though Nepal is self-sufficient in both products because soybean, wheat and corn used in the feed are imported.

“It cost Rs47 just to bring 1kg corn to Kathmandu this time, the highest so far, the price has doubled in a year,” says Rabin Puri of the Grain Producers' Association. Nepal has already imported maize worth over Rs12 billion in the last seven months.

Even so, the real effect of the price hike in the international market is yet to be seen, warns the former president of the Federation of Nepalese Chambers of Commerce and Industry (FNCCI) Pashupati Murarka.

"The goods in the market currently are from stocks. So we are yet to experience a full-scale impact," he says, adding that the cost of construction materials like cement, iron road and plastics will also soon increase. Iron rod has already registered its highest ever price at Rs135 per kg.

Nepal has been experiencing moderate inflation in the past six years. It rose to 7.11% in November but came down to 5.66%. However, the NRB estimates that the inflation rate could reach double digits this year. The monetary policy for the current fiscal year had set a target of limiting the inflation rate to 6.5%.

Former Executive Director of NRB, Nara Bahadur Thapa, says that there is indeed a risk of double-digit inflation. "Consumers have been hit hard again by inflation, with the poorest and most vulnerable bearing the biggest burden," he adds.

On the other hand, rising prices of petroleum products and raw materials in the international market will also increase the production cost of Nepali industries. This means a higher cost of development projects, which in turn will force the government to increase the budget allocation for such projects.

This worsening war also has far-reaching consequences for Nepal’s balance of payments deficit which will widen in the coming months, putting more pressure on foreign exchange reserves.

In recent months, Nepal’s foreign exchange reserves have been depleting fast with imports exceeding earnings. Nepal has lost about 23% of its foreign exchange reserves in the last year.

In January 2021, Nepal had enough foreign exchange reserves to import goods and services for 12 months and 18 days at $12.77 billion, primarily due to reduced consumption during the pandemic.

But as the Covid-19 subsided and imports rose again, its foreign exchange reserves dwindled to $9.88 billion by January this year, enough to pay for only six months and 18 days worth of imports.

In the same period, Nepal's balance of payments deficit stood at Rs241 billion, which is a record high. Such a sharp decline in foreign exchange for a country like Nepal, which does not have a reliable and sustainable source of hard currency earnings, spells disaster.

As commodity prices rise in the international market, Nepal will also have to pay more for the same amount of goods. As of February, the import volume of petrol has increased by only 24% as compared to the same period last year, but due to the increase in the price in the international market, Nepal has to pay 110% more.

Likewise, the import volume of diesel has increased by 10%, yet the cost of its import increased by 84%. While the import volume of coal decreased by 3%, the amount to be paid increased by 38%.

Even though the import volume of iron and steeel products remained the same as last year, the price to be paid by Nepal has increased by one-third.

Nepal has already incurred Rs1 trillion in trade deficit in the first seven months of this fiscal year. While the country spent Rs11.47 trillion in importing goods, it has exported products worth only Rs131 billion.

In response, the NRB in recent months has been deploying various measures to discourage imports. But it is ineffective in the face of international price hikes for commodities. Even if Nepal drastically reduces imports, it will not be able to reduce the amount it is due.

Another major impact of this will be felt in the power sector. Nepal Electricity Authority (NEA) has been importing 600MW of electricity from India. But due to the increased price of coal and supply bottleneck, India has started cutting 200MW that it has been providing to Nepal at a concessional rate. Moreover, Rs3 per unit that Nepal has been paying India has now increased to Rs7.

If India further cuts power export due to an energy crisis, Nepal risks going back to electricity rationing. Although the installed capacity of Nepal's electricity generation now exceeds 2,000MW, it falls to one-third during the dry winter months when river flows is low. The rest has to be augmented with imports from India.

Translated by Sonia Awale from the Nepali original at himalkhabar.com