A bittersweet Monetary Policy 2019/20

Nepal Rastra Bank (NRB) on July 23 unveiled an expansionary Monetary Policy for the fiscal year 2019-20, which has provoked both positive and negative feedback.

In order to support the economic growth target of 8.5 percent for the current fiscal year, the policy adopts a number of measures to facilitate more money supply. Some of them include slashing bank rate from 6.5 percent to 6 percent and reducing the repo rate from 5 percent to 2.5 percent. Similarly, the general refinancing rate has also been lowered to 3 percent from 4 percent.

Major Challenges and Problems

Nepal has been witnessing volatility in both the money market and capital market for the last two year. This can mainly be attributed to the aggressive lending by the banks and financial institutions (BFIs) in contrast to the slow growth in deposit collection. In spite of facing the persisting shortage of loanable funds, they are engaged in raising the interest rate, reluctant to float loans in productive businesses and breaching the central bank’s norms on core-capital plus deposit CCD) ratio and interest spread in particular.

Similarly, the NRB seems to be interested in just revising the conventional tools of monetary policy, which is not enough to curb the current anomalies in the money market.

 “Frankly speaking, the monetary policy has completely downplayed the ongoing liquidity problem and soaring interest rate by only focusing on the economic growth target,” bemoans Shekhar Golchha, senior vice-president of the Federation of Nepalese Chambers of Commerce and Industry (FNCCI).

The demand for loan has mainly shot up with the successive high growth rate that the country has achieved in the past few years, according to him. “It has created a short supply of the loanable fund and the enterprises either are not getting the credit they demand or they are compelled to pay high interest which has helped increase the cost of funds.”

The private sector is irked over the central bank’s move to reduce the spread rate by mere 0.1 percent as it wants such rate to be lowered to 3 percent.

The other concern of the private sector is that the Monetary Policy did not adhere to the productive sector lending requirement. The sector is also unhappy with the policy claiming that it failed to accommodate their demand to increase the size of refinancing fund to Rs 100 billion from the existing Rs 50 billion.

 Similarly, the private sector had also been demanding that the size of the refinancing fund be increased to Rs 100 billion from existing Rs 50 billion, which the policy failed to address. 

However, Nara Bahadur Thapa, former executive director of the NRB, says that most of the measures introduced by the policy are related to reducing short-term interest rate only. “The concerns being raised by the private sector have much to do with reducing the long-term interest rate, which clearly is not the focus of the policy.”

Prospects

NRB has targeted to expand the credit to the government by 24 percent this year, up by 1.5 percent compared to the last fiscal year. Similarly, it will be extending the loan amount to the private sector by 1 percent to 21 percent.

The expansion of credit to both government and the private sector could boost the availability of funds to invest in productive sectors. The central bank has estimated that the government will need to invest Rs450 billion while the private sector needs to inject Rs1.25 trillion in order to achieve the government’s targeted economic growth.

To address the liquidity issue, the monetary policy has also permitted the commercial banks to diversify their sources of borrowing in convertible currency by allowing them to take loans from pension funds and foreign hedge funds. Earlier, banks could take loans only from commercial banks abroad.

The central bank has also allowed banks and financial institutions to collect fixed deposits in foreign currency from organizational foreign depositors and non-resident Nepalis.

To raise the credit flow in the agriculture industry, the policy has made it mandatory for micro-finance firms to disburse one-third of their total loan in the agriculture sector.

As a part of the efforts to stabilize interest rate fluctuations, the central bank last year had reduced the bank rate to 4.5 percent from 5.5 percent, which could not prove effective due to the poor monitoring on the part of the regulator. This had allowed the banks to enjoy large margin almost throughout the year, leaving the customers oppressed. The monetary policy also talks about tightening the spread rate and effectively implementing the interest rate corridor to address the problem of interest rate volatility.

As the Financial Sector Development Strategy (2016-17 to 2020-21) envisions bringing the spread rate down to 4.4 percent by 2020-21 fiscal, the NRB has said banks and financial institutions (BFIs) should reduce the spread rate to the given percent by mid-July 2020. The reduced interest spread is expected to reduce the interest rate on loan thereby providing reasonable benefits to depositors.

Similarly, the central bank has barred BFIs from adding more than two percent interest premium on their base rate while fixing the lending rate on loans up to Rs 1.5 million disbursed in agriculture, entrepreneurship and business promotion sectors. 

Moreover, the central bank, through the Monetary Policy, has barred BFIs from taking any type of service charge from borrowers on such loans. More importantly, NRB has also made it mandatory for BFIs to approve such loan demand within seven days of the submission of application from borrowers.

The Monetary Policy for 2019-20 has targeted keeping inflation within six percent and maintaining foreign exchange reserve to sustain the prospective import of goods and services for seven months.

NRB Deputy Governor Chintamani Shiwakoti says the provision of 25 percent debenture to the banks could help reduce the existing mismatch of deposit and long-term loan. “Banks can retain the money collected through debenture issue until the maturity period of the securities, which they can use to provide long term credit.”

Shiwakoti claims that the central bank has adopted policy to maintain stability in the interest rate. Revised interbank rate to 3-6 percent from 3.5-6.5, reduction in repo rate to 4.5 percent from 5 percent are some of the measures in this regard. Although the policy has focused to address the short-term interest rate, it is expected the reciprocal of interest rate on treasury bills will be passed on to other sectors to improve the situation in the long run.

Although it seems the revised spread rate of 0.1 percent is small in value, it will have larger ripple effect in the market. “By successive reduction in spread rate, NRB has targeted to make it at par to the one being practiced in the international market.”

Shiwakoti says the central bank this time has forwarded monetary policy as a draft paper of the financial sector development strategy adopted by the government.

Meanwhile, the private sector also expresses its hope that the policy this time could help ease the persisting liquidity problems to some extent. “Apart from others, the central bank has talked about providing refinancing facility to the banks and financial institutions. The provision will help ease the liquidity to some extent,” said Golchha.

Way Forward

Analysts said the NRB’s monetary policy shall focus on the unconventional tools rather than the conventional ones being practiced at present. Under the conventional tools, Nepal’s central bank has been using the policy rate, open market operations, and policy corridors, among others, which affect the interest rate at the short end of its spectrum.

Private sectors expressed their concern that the monetary policy this time too does not have tools to bring down the long- term interest rates.

Thapa said the NRB will do well to focus on bringing down the long-term interest rates than the short-term policies like the central banks of Japan, the US and the UK and other European countries are doing. “Quantitative and qualitative easing could be better options in the line.”

He also wants the NRB to launch long term asset purchase program that incorporates the buying credit of certain market segments, revising the calculation method of interest spread, increasing refinancing fund and increasing the productive sector lending. Attracting foreign direct investment by reducing the cost of doing business, legislative reforms such as amendment of NRB Act, reduction of the cost of financial intermediation and improvement in financial access are some of the measures that Thapa put forth to make the monetary policy an effective mechanism.

Though the NRB has been mulling to take the banks even to the forced merger to reduce the number of financial intermediaries, Thapa does not favor the idea of a forced merger. “Especially, development banks, finance companies, and microfinance institutions should not be decimated in the name of mergers and acquisitions.”

Thapa also seeks to introduce necessary laws barring the banks’ board of directors from borrowing a significant scale of loan from the same banks in order to maintain good governance in the sector. 

 “In a bid to impose forced merger of BFIs with cross-holding, the central bank has asked all the BFIs, finance companies and microfinance companies having 0.1 percent share in other companies to provide their details,” says Siwakoti.

He informs that the central bank has allowed the banks to accept fixed deposit from foreign sector to increase the inflow of the foreign currency and to ease existing shortfall of liquidity. For the purpose, the government has started the process to receive the country’s credit rating, which is the utmost requirement when it comes to accepting loan by the private sectors from abroad.

Shiwakoti added that the central bank has not stressed the forced merger among the banks, rather it will provide them an adequate timeframe to move ahead for the unification. According to him, the central bank will enforce stern policy for the banks having cross-holdings.

On the other side, Golchha stressed on the need for implementing the project financing and the loan against personal guarantee to achieve high economic growth as targeted by the government.