External Demand, Domestic Monetary Conditions, and Remittance Dynamics in Nepal

Abstract

This study investigates the macroeconomic determinants and dynamic behaviour of personal remittances as a share of Gross Domestic Product (GDP) in Nepal, emphasizing external demand in major destination countries and domestic monetary policy. Using annual data (1993-2024), we construct composite indices via Principal Component Analysis (PCA) for multi-country external demand and a domestic Monetary Conditions Index (MCI). Our small-sample econometric pipeline includes Autoregressive Distributed Lag (ARDL) bounds testing, Engle-Granger cointegration, Dynamic OLS (DOLS), and a two-step Error Correction Model (ECM). We also employ Granger causality tests and multi-model forecasting using machine learning and ECM scenarios. The analysis reveals a strong positive long-run effect of external demand on remittances and a significant negative impact of tighter domestic monetary conditions. The ECM confirms a stable cointegrating relationship, correcting approximately 26% of disequilibria annually. Medium-term projections indicate remittances will remain structurally important, reaching around 28.3% of GDP by 2030 under baseline conditions, while exhibiting high sensitivity to external demand shocks. This study advances the literature by integrating PCA-derived external demand and monetary conditions indices within a unified ARDL-ECM framework for small samples. Focusing on one of the world's most remittance-dependent economies, it offers actionable insights for monetary policy calibration, migration diversification, and the productive utilization of remittance inflows.