Nepal’s parliamentary elections of November 2022 set the stage for the nation’s slow transition toward federalism, after decades of conflict, political uncertainty and economic challenges. The country remains polarized between the two main party coalitions – the communist parties and the Nepali Congress – which differ sharply on domestic politics, foreign affairs and economic policy. This domestic political contest looks set to continue, hindering economic progress, while halts in aid from the United States may drive Kathmandu closer to its neighbors.
The Himalayan nation has an unfortunate legacy of fragile governance. Thirteen governments have been formed since the monarchy was abolished in 2008, and there is little indication that the current coalition will endure. Since December 2024, a coalition between the major communist party (there is more than one) and the Nepali Congress has been working to overcome the legacy of past divisions.
Nepal’s turbulent politics
Nepal was an absolute monarchy until 2008, with occasional periods of constitutional power-sharing with parliament. In 2001, a crisis erupted when the crown prince killed the king and other royal family members, triggering a prolonged period of constitutional instability. King Gyanendra Shah suspended the constitution and assumed direct authority in February 2005, promising to suppress the Maoist insurgency that had plunged the country into civil war for much of the 1990s.
Public protests forced King Gyanendra to restore the previous parliament in April 2006. In 2008, a Constituent Assembly deposed the king, declared Nepal a federal democratic republic and abolished the 240 year-old Shah dynasty. Since then, intense partisan politics and ideological tribalism have led to ineffective coalition governments in the still-developing country.
Although the civil war officially ended in 2006, its long-term effects continue to hinder Nepal’s democracy. Issues of human rights violations, transitional justice and political accountability all remain concerns for citizens and civil society activists. Rather than healing the decades-old wounds of a people displaced and traumatized by the civil war, the political elite remains engaged in making and breaking coalitions.
The two dominant political forces are the communists and the Nepali Congress (NC), which emerged in the 1940s and was often banned by Nepal’s monarchs, who over several decades, routinely imprisoned its leaders. The communists are divided between the Communist Party of Nepal-United Marxist and Leninist (CPN-UML) and the Communist Party of Nepal-Maoist Centre (CPN-MC). Several splinter left-wing factions also exist in parliament, and communist groups have often formed coalitions with the centrist Congress Party.
After the 2022 elections, CPN-MC leader Pushpa Kamal Dahal, also known by his nom-de-guerre Prachanda, became prime minister at the head of a coalition with CPN-UML. He was then ousted after the CPN-UML formed a new coalition with the Nepali Congress. CPN-UML leader, K.P. Sharma Oli, became prime minister for a fourth time in July 2024 and still holds the post.
Under the terms of the coalition agreement, Prime Minister Oli and the NC leader, Sher Bahadur Deuba, will alternate as prime minister before the next general election in 2027.
A now-growing economy faces challenges
Nepal’s economy relies predominantly on earnings from tourism and the remittances from Nepalese working abroad. Years of civil war had already weakened the economy when the Covid-19 pandemic pushed it further into difficulties. The services sector, the largest contributor to Nepal’s economic output, was badly hit during the pandemic as lockdowns weighed on revenues from tourism and agriculture exports and reduced remittances.
However, over the past two years, there have been signs of recovery. Nepal recorded 4 percent economic growth in 2024, buoyed by revived agricultural exports a 32 percent surge in income from the tourism sector. Remittances, which reached a nine-year high in 2023, are rising and have led to increasing private consumption. Growth in hydropower production by over 450 megawatts (MW), and a rise in rice paddy production have also contributed to Nepal’s recent economic progress.
But, as the World Bank recently warned, there has been a decline in both private and public investment seen in lower imports of intermediate and capital goods and decreased implementation of capital expenditure due to the austerity measures of successive governments.
The country’s fiscal deficit has dropped to a seven-year low, yet revenue collection remains poor and capital expenditure execution is inadequate. Driven by a fall in non-food and services inflation, the headline inflation rate eased to 5.4 percent in 2024 from 7.7 percent a year earlier.
External account difficulties are somewhat perennial. Since 1976, Nepal has borrowed from the International Monetary Fund (IMF) on nine occasions to avert balance of payments crises. The latest Extended Credit Facility of $372 million started in January 2022 and is expected to expire this year. While Nepal’s economy is in a better position today than it was in 2022, the IMF has expressed concern that it is still underperforming.
The IMF has also noted Kathmandu’s failure to quickly execute capital projects that could provide much-needed stimulus and boost economic growth. The political environment remains fragile due to frequent coalition changes that hamper policy continuity and prevent the implementation of economic reforms. The IMF is also apprehensive about the soundness of the Nepalese banking system, especially of public sector banks.
Located high in the Himalayan mountains, Nepal remains vulnerable to natural disasters such as earthquakes and floods and is overly dependent on the goodwill of donor countries. Several elements of the economy, including electricity exports, foreign exchange surpluses and foreign direct investment inflows depend on maintaining good relations with India, China and the U.S. The decision by U.S. President Donald Trump to halt foreign aid will add to the challenges facing Nepal (and other countries).
Nepal’s foreign policy has been predicated on relations with India
Nepal has traditionally sought to balance ties with its large neighbors, India and China. As a landlocked nation, Nepal needs their goodwill to effectively trade with the world. India holds historical and sociocultural influence over Nepal, which like India is predominantly Hindu, and shares deep civilizational ties. The relationship between the two countries has remained strong since the end of the British Raj on the subcontinent in 1947.
Nepal is the only neighbor of India that has a visa-free arrangement with the country. This arrangement offers New Delhi geopolitical advantages and brings economic benefits to Kathmandu. India-Nepal bilateral trade accounts for 64 percent of Nepal’s total external trade, reaching $8.85 billion in 2023. Of this amount, Nepal’s exports to India total around $850 million, the remainder being imports from India of petroleum products and manufactured consumer items.
New Delhi has helped Kathmandu harness its hydroelectric potential, enabling electricity exports to India and other neighbors, such as Bangladesh. Recently, Nepal and India signed power trade agreements to ensure 10,000 MW of electricity imports to India over the next decade. This may help reduce the trade imbalance that is currently heavily in India’s favor.
Nepal is among India’s top recipients of development assistance and emergency aid. New Delhi has also provided humanitarian assistance and disaster relief to Nepal during both natural and human-made disasters, including earthquakes and Covid-19. In 2021, India delivered 23 tons of critical medical supplies and 100,000 doses of Covid-19 vaccines. Then, in November 2023, India offered immediate help following a deadly earthquake. India’s development assistance also encompasses connectivity projects, such as airports and pipelines.
Relations between the two countries have nevertheless oscillated, primarily because India plays a larger-than-life role in Nepal’s politics, society and economy. Nepal’s communist parties prefer closer ties with China, while the Nepali Congress has advocated for closer ties with India and good relations with the U.S. Domestic critics play on fears of Nepalese culture being overwhelmed by Indian culture and identity, as well as concerns over India’s economic power and military muscle.
Kathmandu’s relations with Beijing and Washington
Nepal has tried to balance its ties with India by fostering close relations with China. Nepal’s bilateral trade with China stands at around $2 billion, of which Nepal’s imports are worth $1.78 billion. In 2017, Nepal joined China’s Belt and Road Initiative (BRI) and proposed 35 projects to Beijing, totaling $10 billion, nine of which have been approved. Seven of these projects have broken ground, including a major highway upgrade, an electricity transmission line, a railway project, two hydroelectric plants and a science research grant for a Nepali university.
Nepal has received $2 billion as of 2021 under the BRI, but several projects have encountered complications. Coincidentally or not, China expressed concerns about faulty project execution by Nepal when the country began to openly worry about the risks of borrowing from China after the 2022 Sri Lankan debt crisis. In 2023, Nepal and China initiated the Lektse dry port, through which Nepal can sell salt and grain to China. More recently, in December 2024, Prime Minister Oli visited China and signed 10 new projects under the BRI.
The U.S. is Nepal’s second-largest export market after India, with exports to America standing at $152 million in 2024. U.S. aid to Nepal rose to $262 million in 2015 due to the devastating earthquakes that year and $685 million in 2023 after another wave of severe tremors. In 2017, under the Millennium Challenge Corporation, the U.S. signed a $500 million investment agreement known as the Nepal Compact. The bulk of this investment has been for building Nepal’s electricity grid infrastructure, especially improving electricity distribution throughout the Nepalese grid. Another project is aimed at improving road infrastructure through periodic road maintenance.
The Americans, nevertheless, are concerned that Nepal may be letting China dominate the Himalayan region. Furthermore, the future of American aid to Nepal now hinges on the whims of President Trump.
Scenarios
Most likely: Imperfect political continuity at the expense of stability and growth
Moving forward, the most likely scenario is that wrangling for power among Nepal’s major political parties will continue to impede longer-term stability and development. If Prime Minister Oli keeps his promise to Congress leader Deuba and allows him to become prime minister for the second half of this parliament term, elections will not be held until 2027. The diminution of U.S. aid will result in Nepal having to turn more to India and China for both investment and assistance.
Less likely: A new coalition government emerges
A less likely scenario is that the Oli-Deuba partnership cracks and Prime Minister Oli, Mr. Deuba or Maoist Centre leader Dahal will try to form a new and likely unstable coalition. Early elections would then be a possibility but are unlikely because members of parliament are averse to their terms being cut short and they often switch parties or form new factions within parties to extend terms in power. The next prime minister will likely continue with the current model of economic growth, though if the Maoists have their way, Nepal will switch to China from India as the preferred development partner.
Least likely: Economic frustrations lead to domestic clashes
The least likely scenario is mass unrest due to economic problems and a return to violence or civil war. If, akin to what happened in Sri Lanka in 2022, the economic crisis worsens to the point that the country is unable to pay for the import of essential commodities, then economic frustration could spill onto the streets. Nepal went through decades of violent civil war when the Maoist movement was at its peak. Economic distress could reignite ethnic tensions, and extremist groups might again take up arms.