As if things were not bad enough in 2001 with the insurgency, royal massacre, Nepal bandhs and strikes, the post-September international crisis has made prospects for Nepal's economic recovery suddenly much worse.

Domestic and foreign investment is below zero, as even those already in Nepal pull out. The purchasing power has been hit, the public is not shopping this Dasain. Alcohol, which was one of the most profitable industries has been a victim of scare tactics by Maoist women. Shares of the Himalayan Distillery were floated a month ago, but only Rs 30 million of the expected Rs 173 million had been raised till last week. Banks and finance companies that underwrote the issue will take the remaining shares. This used to be unheard of-shares of even suspect ventuers have always been oversubscribed.

The writing on the wall is clear: the economy is going into deep freeze and may already be in recession.
Some early signs are the slowdown in exports, the slump in tourist arrivals and lower government revenues reflecting falling receipts from the sales of beer and alcohol. Then there is capital flight due to political uncertainty and the panic that followed the prime minister's "revolutionary" land reform plan. Even investments that were in the pipeline are now held up by the confusion. A weak monsoon in the eastern tarai grainbasket is bound to affect overall agriculture production and the overall economic growth.

The lack of business confidence, and early signs of a slowdown are already apparent in this year's Dasain bazaars. "The crowds are there, but they are buying very little," says Rajesh Kaji Shrestha, of the Nepal Chamber of Commerce. "Shopkeepers are trying to clear stocks and few are replenishing or ordering new supplies, which is a sure sign of recession."

The Himalayan Distillery public issue could have done better had it not been for the Maoist prohibition scare. The government managed to get the pro-Maoist women to agree to four dry days a month and stricter enforcement of drinking age and control of sales. But that did not stop Maoist supporters from razing the Shah Distillery in Nepalgunj in August after the government and the rebels had agreed on a "ceasefire."
Despite the rocky scenario, Nepal's macroeconomic indicators look surprisingly healthy-apparently buoyed by years of good monsoons, exports and remittances from Nepalis abroad. It is also a result of appropriate exchange rate, monetary and fiscal policies. But economists warn that in the face of continued political instability, even this achievement may begin to fray.

At the "Article IV" consultations held in August, the International Monetary Fund (IMF) gave Nepal a not-too-bad rating mainly because of our macroeconomic health over the last few years. But as long as there is uncertainty in the peace process and lack of confidence in the government, fiscal discipline will almost certainly begin to creep in. That happens when weak governments are forced to buy political support with handouts.

"The market looks upbeat now but this may not last past Dasain," says Rajendra Khetan of the Federation of Nepalese Chambers of Commerce and Industry. "It is a problem of lack of confidence and we just don't know what is ahead."

The IMF Staff Report foresees two medium-term scenarios: high growth and low growth trajectories. Political and economic stability are crucial for Nepal to take the high growth road. If the Maoist insurgency and political instability persists, then the IMF foresees a low growth scenario.

If Nepal wants to aim for high-growth it needs to fully implement reforms to achieve 6-7 percent GDP growth. This would entail keeping inflation under five percent, increasing domestic savings and maintaining comfortable foreign exchange reserves. All this can happen with political and economic stability, which could then lead to increase in agricultural production, as more irrigation systems get built, and there is investment in new hydro and road construction projects.

GDP in the low-growth mode would hover at around three percent-a direct fallout of political uncertainty and a slowdown in the pace of reforms. Continued political unrest would trigger downslides in private investment and tourism receipts. A slowdown in agriculture growth would lead to lower demand for non-agricultural goods. Slow reforms would mean a net decrease in donor assistance-because we won't be able to spend it. All of which would have a domino effect on fiscal discipline and inflation.

The political stability business needs now is not only restricted to resolving the Maoist problem. It is equally important to have a strong government that can focus on public policy. Whether and when this will happen is hard to tell, given the ruling party's well-known propensity for infighting. A best-case political scenario is a united Left forming a government, the possibility of which has been pushed further away after the Marxist-Leninists have decided that it will hold no more talks with the main opposition UML. A Left government would bring stability in government and isolate the Maoists, but it will disrupt much-needed economic reforms with which the comrades have ideological problems.