The government should investigate threats and attacks against LGBT people the rights body said.
Widespread harassment including by the government has contributed to a climate of fear among LGBT people and activists in Nepal and has interrupted vital activities including HIV prevention work it said.
The LGBT rights movement in Nepal is a regional and international leader but is under serious threat said Graeme Reid director of the LGBT Rights Program at Human Rights Watch.
While Nepal has made immense progress on LGBT rights in the past decade the government cannot afford to ignore the many problems facing LGBT people inside its borders.
Attacks on Nepal's LGBT activists have escalated in recent months from threats against individuals to physical violence and abduction Human Rights Watch said.
Over the past six months LGBT rights activists have reported being harassed by threatening text messages and being followed by people wearing masks who attempted to extort money or sex.
Some have been forced by these masked figures to make negative on camera statements against Blue Diamond Society the national LGBT umbrella organization.
In December the Blue Diamond Society asked the inspector general of Nepal Police to investigate threats against staff members including threatening phone calls and being followed after dark.
However these and other threats and intimidation have neither been investigated nor punished and have contributed to a climate of fear among LGBT people.
Many have been unable to congregate in public conduct HIV prevention outreach activities or express their views without fear of threats or reprisal.
Government harassment of the Blue Diamond Society has seriously threatened the group's activities Human Rights Watch said.
Government officials have been delaying the renewal of the group's operating licence.
A series of television news stories alleging corruption and incompetence by the Blue Diamond Society led to a government probe which halted the annual NGO licence renewal process and froze its bank accounts.
Nepal's government has made significant strides toward ensuring equality for LGBT people in recent years including recognizing a third gender category on official documents.
The government has also completed a proposal to amend all laws that discriminate on the basis of sexual orientation or gender identity in line with a landmark 2007 supreme court decision.