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Monetary Policy 2016-17

Nepal Rastra Bank (NRB) – the central regulatory and monetary authority – has made strategic shift in monetary operations through introduction of Interest Rate Corridor (IRC) in the Monetary Policy 2016-17. The IRC had long been suggested by the International Monetary Fund (IMF) for the predictability of interest rates which is crucial in creating an investment-friendly environment in the country. Monetary Policy has also taken some critical steps towards price stability, financial sector stability and external sector stability.

The Monetary Policy has targeted to keep inflation below 7.5 percent which is challenging for the Central Bank as the government introduced expansionary fiscal policy for this financial year. However, the Central Bank has clearly stated in the Monetary Policy that the Central Bank will not be able to tame inflation spiked by supply side constraints as it has witnessed rampant inflation in the last fiscal due to supply side challenges. Low supply in the market due to supply line disruptions from India flourished black marketing and hoarding in the market causing double-digit inflation in the last fiscal. The Central Bank has said that it will be able to keep inflationary targets at desired level caused by the demand side. The government has pushed NRB into a challenging corner by fixing inflationary target of 7.5 percent for this fiscal through fiscal budget 2016-17. The Central Bank has responded the government that it can maintain 7.5 percent target only if government ensures smooth supply and proper storage of the essential commodities.

The Monetary Policy has set target to expand private sector lending by 20 percent to achieve economic growth target of 6.5 percent set by the government. It has also envisioned tightening broad money supply to keep inflation at desired level. The government achieved 0.77 percent growth in the last fiscal as broad money supply surged by around 18 percent. However, NRB has said that it will tighten broad money supply growth to 17 percent this fiscal. In addition, NRB has announced setting counter-cyclical buffer requirement for commercial banks – as part of implementing the Basel III standard – at a maximum of 2.5 percent. Such buffer capital is intended to cover losses when there is sudden volatility or risk in the economy. This capital is drawn from banks when they are in profits. There will be contraction in credit expansion due to additional counter cyclical buffer on top of the existing Capital Adequacy Ratio (CAR), say bankers.

Major Changes

Interest Rate Corridor (IRC): The Central Bank has introduced IRC for the predictability of interest rate. All types of interest rates like in repo, reverse repo, treasury bills, government bond, deposit, lending, inter-bank rates among others will move in this corridor. Interest rate on reverse repo is lower bound and interest rate on Standing Liquidity Facility (SLF) is upper bound. Normally, there will not be a huge gap in any type of interest rate from the policy rate or repo rate of the NRB which moves from the centre of the corridor. NRB adds 200 basis points (2 percent) on the interbank rate of two days back while issuing repo to banks and financial institutions (BFIs). The IRC is expected to address the interest rate volatility in the long run.

Tightened Margin Lending:  NRB has also revised the policy of margin lending or loans against share collateral. BFIs will be able to float only 50 percent loans on the valuation of average trading price of shares of the last 180 days or the late market price of the share, whichever is lower. Earlier, BFIs were allowed to issue up to 60 percent loan against share collateral on the aforementioned valuation. The Central Bank has tightened the margin lending to curb the flow of finance towards stock market as the country‘s only trading bourse has been roaring due to cheaper financing facility from the banking system.

Rupee

Reduce the level of institutional deposits:  The Central Bank will not allow BFIs to obtain more than half of their total deposit from institutional depositors like Employee Provident Fund, Citizen Investment Trust and various other welfare funds. Earlier, BFIs were allowed to obtain up to 60 percent of the deposit from institutional depositors. This provision has increased the cushion of household and individual savings.

Direct lending provision:  Commercial Banks have to lend two percent of their total loan portfolio to the deprived sector from their own capacity. Commercial banks need to allocate five percent of their total loan portfolio to the deprived sector. They are maintaining the deprived sector lending criteria set by the Central Bank through providing funds to Micro Finance Institutions (MFIs). MFIs -class ‘D‘ financial institutions – are specialised institutions for deprived sector lending. As per the current provision, Commercial Banks have to lend Rs 28 billion (on current lending level of the Class ‘A‘ banks) directly to the deprived sector. However, the monetary policy has allowed commercial banks to count loan up to Rs one million issued in agriculture sector as deprived sector loans. This provision may help commercial banks to meet the target of two per cent lending in the deprived sector.

Loan to energy and agriculture hiked:  The Central Bank has hiked the minimum requirement of 12 percent for commercial banks on the productive sector lending on agricultural and energy sectors to 15 percent. However, NRB has kept 20 percent mandatory lending for commercial banks to the productive sector unchanged. Commercial banks will now have to float 20 percent of loans in productive sectors and 15 percent of such loans must be extended in agriculture and energy sectors.

No cash transaction above Rs three million:  Central Bank has reduced the threshold of cash transaction from Rs 5 million to Rs 3 million. With the reduction on the threshold level, people will have to use cheques or other negotiable instruments for transactions above Rs 3 million. Cash transaction threshold has been reduced to minimise risks. This measure will also support corruption control, tax evasion, flow of illicit funds and other risks.

Increased consortium loan ceiling:  The Monetary Policy has increased the ceiling of consortium loans to above Rs 1 billion from Rs 500 million. Consortium loan provision has been introduced to downsize the risks of credit flow to ventures of influential people who have hold in particular banks. The provision of consortium will control the chances of credit flow in somebody‘s influence because there will be two to three banks involved in loan of above Rs one billion as per the recent provision of the monetary policy.

Capital increase and 7 percent interest rate spread to MFIs:   The Central Bank has raised the capital of MFIs involved in wholesale lending by six folds. MFIs – class ‘D‘ financial institutions – need to raise capital to Rs 600 million from existing Rs 100 million by the end of fiscal 2017-18. NRB has also imposed seven percent interest rate spread to the MFIs. As per the provision, MFIs cannot add more than 700 basis point (or seven percent points) on interest rate in which the MFIs borrowed from other financial institutions while lending. This provision on MFIs was introduced following the five percent interest spread cap on commercial banks. Seven percent interest cap for MFIs is on the cost of fund of microfinance institutions. In general, interest spread refers to the difference between the interest rates that a financial institution charges on its loans and the interest rates that it provides on deposits. Here for MFIs, deposit means the money borrowed from other financial institutions. NRB introduced this provision to safeguard borrowers in remote areas compelled to pay high interest rate to the MFIs which they practice in remote areas citing high operation costs.

CSR and training:  NRB has issued provision of mandatory training for staff and board of directors. As per the provision of the monetary policy, the BFIs must mandatorily earmark 3 percent of their staff expenses towards training fund to enhance HR capacity. Monetary Policy has also provisioned Board of Directors Education Programmeme to strengthen corporate governance and risk management. Board of Directors, due to lack of understanding, are seen playing less effective role, and the executives have been influencing decision making of the BFIs. Also, BFIs have to allocate one percent of their gross profit to corporate social responsibility (CSR).

Foreign Exchange facility:  The Monetary Policy has increased foreign exchange facility to traders. Traders importing goods from third-countries using instruments like draft and telex transfer will be extended foreign exchange facility of up to 50,000 US dollars for one-time payment. Similarly, traders buying software from India are allowed to acquire one-time letter of credit worth upto 15,000 US dollars from existing 10,000 US dollars. Nepali foreign currency account holders are allowed to purchase goods and services worth 15,000 US dollars per year from abroad. The Central Bank will also fix the selling rate of Swedish Kroner, Danish Kroner, Hong Kong Dollar, Kuwait Dinar and Bahrain Dinar. NRB publishes only the buying rates of the aforementioned currencies. Currently, NRB extends both buying and selling facility in 16 foreign currencies including Indian Rupee. This will be beneficial for the migrant workers, according to Bhisma Raj Dhungana, Executive Director of Foreign Exchange Management Department. Likewise, the Monetary Policy has also talked about certain capital requirement for remittance companies and money changers. The Central Bank will fix the minimum capital requirement for them through the directives in future.

Contradictory steps

The Central Bank had decided to increase the capital of BFIs up to four folds through Monetary Policy in the last fiscal. BFIs have to meet the capital requirement criteria by the end of this fiscal. As capital has been increased, BFIs need to expand credit to achieve desired profits. In this scenario, the contractionary monetary policy cannot be considered good for profitable growth of BFIs. Banks are worried about NRB‘s announcement to set countercyclical buffer requirement for commercial banks, as part of implementing the Basel III standard, at a maximum of 2.5 percent. Currently, banks have to maintain 10 percent capital adequacy ratio based on total risk weighted assets. Further, they require another one percent capital conservation buffer to distribute dividends. The NRB is planning to execute two percent‘s counter cyclical buffer by 2018. In the first round, it will execute 1.25 percent counter cyclical buffer by 2016, 1.5 percent by 2017, and two percent by 2018 on top of the capital adequacy ratio. “This ultimately hurts credit expansion capacity of banks which is a must to make profits,” said Sashin Joshi, Chief Executive Officer of Nabil Bank.

NRB, in contrast to the rising flow of foreign aid and modest remittance growth has expected net foreign asset growth to drop to 5.4 percent from current 23 percent. The NRB‘s projected figure for net foreign asset growth is unreachable. Economists opine that the Central Bank has set inflationary target keeping in mind foreign asset growth will remain at 5.4 percent, but the fact is that it will remain at the same level of this fiscal, explained Krishna Bahadur Manandhar, former Acting Governor of the NRB.

Mixed opinions

The business sector has hailed the monetary policy as it has expanded the size of consortium loan to Rs one billion from Rs 500 million. Business people were compelled to negotiate with at least three to four banks to obtain credit because the Central Bank had provisioned all loans above Rs 500 million to be mandatorily issued through consortium financing. “The provision of consortium on smaller amount of loan had created hassles,” said Hari Bhakta Sharma, President of Confederation of Nepalese Industries. However, bankers had lobbied with NRB to downsize the amount of consortium loan to Rs 250 million to minimise risks, according to Upendra Paudel, President of Nepal Bankers‘ Association.

On MFI‘s, Paudel says that the provision of direct lending to deprived sector policy will increase the operational cost of banks. “We were providing the fund to MFIs even below cost to maintain the deprived sector lending portfolio. Now to mobilize the funds, commercial banks need to set up additional networks and staff in remote areas which will be cost-intensive for the class ‘A‘ financial institutions”.

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