Nepal: Natural disasters will pose challenges to economic prospects

Event

On 26 August, flash floods along the Nepal-Chinese border – likely caused by the massive collapse of a glacier in the Himalayas, which also generated seismic activity – destroyed several villages and critical infrastructures. Authorities reported more than a thousand people dead and thousands of people missing. The ice-rock avalanche destroyed several dams – accounting for close to 10% of the country’s electricity production that primarily depends on hydropower – and brought trade through the corridor with China to a halt. According to scientists, years of above-average temperatures induced by climate change are likely to be blamed for this catastrophic event.

Impact

Located in the Himalayas, Nepal is highly vulnerable to the accelerating melting of glaciers. The rapid development of hydropower projects could significantly amplify the impacts of similar events, whose frequency is likely to increase as temperatures rise. Managing the humanitarian and socioeconomic consequences of these devastating floods will be an early test for PM Balen Shah, who took office in March after a landslide victory at the parliamentary elections. This disaster adds to the fallout of the conflict in the Middle East, whose impact on Nepal’s economy is already felt through higher fuel costs and as a threat to workers’ remittances. The forced suspension of bilateral trade with China and the costs of economic recovery will weigh on economic activity and public finances. That said, compared to regional peers, Nepal’s public finances are sustainable, with a contained fiscal deficit and a moderate public debt (below 50% of GDP). Foreign exchange reserves are healthy at more than 10 months of imports and more than sufficient to finance a modest external debt service. However, given that a large share of foreign exchange revenues comes from Gulf remittances, a protracted conflict in Iran could pose a risk.

Even though reconstruction works should support economic activity over the one-year outlook, long-term economic prospects could be affected. First, given the intensification of climate change, Himalayan floods linked to glacier melting are likely to become more than a one-off shock. They represent a fast-rising risk that the Nepalese authorities will have to address. Adapting to this fast-rising risk will be highly challenging for Nepal’s low-income economy, notably amid declining international aid. Securing long-term access to natural water flows will also become a growing challenge. Second, as hydropower plants are a government priority for power generation and electricity exports, risks related to natural disasters should be taken into account to protect the people living in the valleys. Indeed, deeper impact analyses are warning about the climate impacts of China’s mega dams projects in Tibet (including the world’s largest hydropower dam on the Yarlung Tsangpo River). The latest deadly natural disaster could thus lead the Nepali authorities to enhance consultation with Beijing around further hydropower projects. Increased attention and investment could also be allocated to climate change resilience. Third, mountain tourism, an important source of revenue for local people, could be a collateral victim of the recent devastating floods given the higher risk of similar avalanches occurring in the future.

Nepal’s country risk ratings remain unchanged for the time being.

Analyst: Raphaël Cecchi – r.cecchi@credendo.com