A landlocked Nepal may head towards its South Asian neighbor Sri Lanka's apocalyptic economic woes with its impending foreign exchange crisis.

According to Nepal's central bank, the country's foreign exchange reserve can sustain only six months of imports which increased uncontrollably, denting the forex reserve by 17 percent to $9.75 billion in February 2022 from $11.75 billion in June-mid in 2021.

Inflation has gone up from 2.77 percent in 2020 to 5.97 in 2022, making everything from food to fuel to clothes dearer.

The Philippines-based Asian Development Bank has predicted Nepal's current account deficit would widen to 9.7 percent of GDP in the current financial year from 8 percent in 2021.

Massive imports fuelled by uncontrolled credit expansion took the Himalayan country to the worst economic crisis. Economists say that loans taken from international agencies were used for unproductive sectors and to foot the bill for imports, which resulted in uncontrolled credit expansion.

Multilateral lending agencies such as Asian Development Bank, World Bank, and IMF are the biggest donors to the country. In January this year, the IMF approved an Extended Credit Facility (ECF) of $395.9 million for Nepal, and $110 million was available for disbursement in January itself.

To prevent its economy from going the Sri Lankan way and to preserve its forex kitty, bankers in Nepal have decided not to issue letters of credit (LCs) for the import of luxury goods.

An executive meeting of the Nepal Bankers' Association, an umbrella organization comprising chief executive officers of 27 commercial banks, on April 10 took a decision not to issue an LC for the import of luxury goods because of dwarfing foreign exchange reserve, which, the central bank said, has dwindled to its lowest level in recent months.

The Nepal Rastra Bank (NRB) had told the Finance Ministry that the country would not be able to import the most essential goods if the scarce foreign currency reserve was set aside for importing luxury items.

Adhering to the central bank's directives, commercial banks will not issue LCs for the import of luxury goods like vehicles, gold, silver, dry food, furniture, cigarettes, alcohol, perfumes, mobile phones, and chewing gum.

"This is not banning the imports but discouraging them," NRB deputy spokesperson Narayan Prasad Pokharel told Reuters.

Nepal's Finance Minister Janardhan Sharma refuted the claim that the country's economy will nosedive like that of Sri Lanka. At the National Conference on Economics and Finance, organized by NRB on April 8, Sharma stated that the country's economy is not on the brink of crashing.

Earlier, the Nepal Rastra Bank had imposed a 50 to 100 percent cash margin on the import of 47 items due to depleting foreign exchange reserves.

Despite fertile land, Nepal imports cereals, meat, fish, vegetables, and fruits, spending billions of foreign currency. The agriculture sector is overlooked by the government and farmers are rarely given incentives to encourage them in farming.

Like Sri Lanka, the Himalayan country's foreign reserves were hit by a slump in tourism during the Covid-19 pandemic. With tourists refusing to come to the country of some 29 million people, Nepal's gross foreign exchange reserves fell to $9.75 billion by mid-February, a decline of 17 percent from mid-July 2021.

Like in the case of the Sri Lankan diaspora, remittances from overseas Nepalis came down by 5.8 percent to $4.53 billion between mid-July to mid-February.

When tourism was affected due to the pandemic, NRB pumped in around Rs 153 billion ($1.25 billion approx.) into businesses like tourism and SMEs at an interest rate of 5 percent. But, clever Nepalis invested the money in the share market and in real estate as the interest rates were low.

As energy and commodity prices are soaring in the international market, the problem has been further aggravated in the country. Though the country managed to export goods worth Rs 147 billion ($ 1.20 billion approx.), the rise in imports played the spoilsport.

To cause embarrassment to the central bank's autonomy when the state of the economy is not in good shape and elections are around the corner, Prime Minister Sher Bahadur Deuba's government April 8 suspended NRB Governor Maha Prasad Adhikari, for his alleged role in leaking sensitive financial information to the media. Adhikari was appointed on April 6, 2020, by the previous regime.

Political leadership in the country has been seeking Adhikari's scalp ever since the economic situation in the country took a worse turn. At the recent cabinet meeting, Adhikari's performance figured high on the agenda and Maoist Centre chair Pushpa Kamal Dahal and CPN (Unified Socialist) chair Madhav Kumar Nepal insisted on the government show Adhikari's the door.

As internal resources are difficult to mobilize Nepal depends on FDI to boost its foreign reserve. Maybe Nepal can woo China and India, which are jostling for power in the country, to attract more FDI. If the country's tourism sector starts ticking, together with FDI it can prevent Nepal from going the Sri Lankan way.