With immense strains on foreign exchange reserves and ballooning Balance of Payments (BoP) deficit triggered by increasing import dependence, Nepal Rastra Bank (NRB) – the central regulatory and monetary authority – has introduced some stringent measures through the Monetary Policy 2022/23 unveiled on July 22.
The Monetary Policy 2022/23 is deemed to be the most rigid in NRB’s 20-year history of formulating monetary policies starting from fiscal year 2002/03. In general, it is drafted to address external sector stability, price stability and support domestic economic activities through proper mobilisation of private sector credit in line with the clearly defined objectives of the central bank.
Lower Private Sector Credit Mobilisation And Money Supply Target
To discourage import-based consumption, NRB has lowered the estimates of money supply and credit mobilisation to the private sector to 12% and 12.6%, respectively. In the previous fiscal, the money supply target was 18% and private sector credit mobilisation was expected to hover at 19%. However, slowdown in government expenses and prolonged liquidity crisis stalled the growth of money supply at 9% and private sector credit growth at 16%.
The overall orientation of the Monetary Policy is to discourage the availability of cheaper funds for consumption to address the current strain on forex reserves and to tame rampant inflation. The country has witnessed import growth of 24.7% to Rs 1,920.45 billion against total export size of Rs 200 billion resulting in a trade deficit of Rs 1,720.42 billion.
Import volume has surpassed the sum of remittances, exports, tourism income, foreign direct investment and reimbursements received from execution of donor-aided development projects. The widening gap in foreign currency inflow and outflow has caused a depletion of foreign currency reserves. NRB Governor Maha Prasad Adhikari has said that the country can’t go beyond its capacity in settling import bills by exhausting forex reserves.
For this fiscal, NRB has also raised the rates of injecting liquidity to BFIs through monetary instruments, namely Standing Liquidity Facility (SLF), Intraday Liquidity Facility and Repo. NRB has said it has injected liquidity worth Rs 9,702.41 billion in the previous fiscal whereas rates of SLF and repo were prevailing at 7% and 5%, respectively.
Monetary Instruments To Act In Full Swing
The aim of the Monetary Policy 2022/23 is to avoid an economic crisis, according to Anal Raj Bhattarai, financial sector analyst. “However, the central bank started policing trade-related rules through banks. It would have been better if the Ministry of Industry, Commerce and Supplies had taken the lead considering the threat posed to the country’s macroeconomic stability due to deep-rooted structural constraints of our economy, and the ballooning trade deficit,” he said.
NRB has brought monetary instruments into full swing to discourage credit mobilisation for undue imports and consumption of foreign goods, however regulating the country’s trade through the financial sector doesn’t make sense. However, central bank authorities as the custodian of the country’s foreign currency reserve have claimed that they have initiated such policy measures to tame inflation that is heading towards hyperinflation due to the global commodity price rise triggered by various factors.
The NRB Act has extended responsibility of the custodian of foreign currency reserves and stability of BoP to the central bank. By mid-June this year, BoP situation recorded a deficit of Rs 269.81 billion, and foreign currency reserve was at $9.45 billion, sufficient to cover import of goods and services for 6.73 months.
Through the Monetary Policy to be executed in the current fiscal, the central bank has lowered the maturity period of SLF to five days from a week. Likewise, CRR (cash reserve ratio) or the fund that BFIs require to park at the central bank vault has been raised to 4% from 3% of the previous fiscal year as per its objective to lower the money supply target. Interest rate corridor rates have been raised by 1.5 percentage points.
Financial Sector Stability Is Key
Along with CRR, the central bank has also raised the requirement of Statutory Liquidity Ratio (SLR) and announced executing counter cyclical capital buffer requirements from the upcoming fiscal to ensure stability in the financial sector.
Commercial banks (Class ‘A’ financial institutions) have to maintain SLR at 12%, whereas it is 10% for development banks (Class ‘B’ financial institutions) and finance companies (Class ‘C’ financial institutions) by mid-January 2023. It has also announced to execute counter cyclical buffer from the upcoming fiscal suggesting BFIs for necessary preparations to be flexible for a year to enter into the aforesaid policy regime. However, BFIs that merge with financial institutions of the same class will enjoy flexibility of an additional six months to abide by the counter cyclical capital buffer related instructions, according to the Monetary Policy 2022/23. The countercyclical buffer aims to ensure that the banking sector capital requirements take account of the macro-financial environment in which banks operate.
The Monetary Policy 2022/23 has paid a lot of attention to financial sector stability considering the potential pressure on the financial sector due to delays in loan recovery, defaults and prolonged liquidity crisis. The central bank will now start monitoring large borrowers.
Likewise, banks and financial institutions have been asked to extend loans of up to 30% of the fair market value in Kathmandu valley and up to 40% outside Kathmandu valley against collateral of land. The Monetary Policy has scrapped the provision of single borrower limit of Rs 40 million from one bank or financial institution against collateral of stocks, however it has introduced cent per cent risk weightage required for loans of up to Rs 2.5 million and 150% for loans above Rs 2.5 million. The single borrower limit for credit against collateral of stocks remains unchanged at Rs 120 million.
Another major announcement of the Monetary Policy 2022/23 is to encourage merger of Nepal Infrastructure Bank (NIFRA) particularly with a financial institution with similar objectives of financing in infrastructure in a bid to enhance the investment capacity through larger paid-up capital base of the financial institution. Though it has not been officially stated, sources at the NRB, privy to this development, have said that NRB intends merger between NIFRA and Hydroelectricity Investment and Development Company Ltd (HIDCL).
NRB During Covid & Now: No Such Thing As Free Lunch
During the Covid pandemic, Nepal Rastra Bank took on the role of a facilitator more than that of a regulator which resulted in the flow of cheaper credit, low repayment and loan-greening as borrowers were granted loan rescheduling and restructuring facilities. Cheaper credit and relaxation granted for repayment have been assumed to have triggered imports that can be seen in the increased volume of imports.
Existing pressure on BoP as well as foreign exchange reserves is not only because of the central bank’s generosity during Covid but was also triggered by the increased import bills along with global commodity price rise in the post-Covid scenario aggravated further by the consequences of the Ukraine-Russia war.
Immediately after the pandemic, the central bank had announced that it could provide refinancing of up to Rs 212 billion through funded and non-funded sources, which is quite high compared to the central bank’s funded source of only Rs 48 billion. However, the optimum refinancing rolled out during the peak period stood at Rs 160 billion and was gradually lowered based on feedback from the International Monetary Fund. The Monetary Policy 2022/23 has announced it will limit refinancing facility allowed by funded source only by 2023/24. Recovery of credit under refinancing facility will be expedited to achieve desired targets in a way that suggests there is no such thing as a free lunch.
Monetary Policy Vs. Budget
The central bank has introduced a stringent Monetary Policy against the expansionary budget unveiled by the government. As the government has envisioned achieving economic growth of 8% by executing Rs 1,793.83 billion budget in fiscal year 2022-23, the Monetary Policy has aimed to support the government’s growth target by maintaining its monetary targets — keeping foreign exchange reserves sufficient to cover import of seven months, 12% money supply growth and 12.6% private sector credit growth, among others.
However, the given monetary targets in fact do not support the government’s ambitious economic growth target in this fiscal considering 5.8% growth projected in the previous fiscal despite 16% credit growth to the private sector and high imports and consumption along with the low growth in previous fiscal years.
There will be significant contraction in imports in the ongoing fiscal that will lower import-based consumption and BFIs will have to be prepared to navigate through tough times.
NRB Governor Adhikari has signalled that cheaper credit could be far-fetched for traders, particularly importers as inflation is skyrocketing towards the double-digit path. Higher inflation and lower interest rates on deposit mean depositors are losing the value of their savings. He has urged borrowers to be prepared to deal with higher credit rates. Interest rate on deposits vis-à-vis inflation must be adjusted to encourage savings which is the only way to address the prolonged liquidity crisis, according to him.
Moreover, the Monetary Policy has announced that it will introduce different interest rates for productive and trading sectors.
NRB has introduced several measures to narrow down imports by elevating interest rate of credit since the second half of the last fiscal including the provision of cent percent margin to open L/Cs and increased risk weightage of credit issued for imports, which are being continued, according to NRB Spokesperson Gunakar Bhatta. Such measures along with strict provisions for credit mobilisation for imports, real estate and stock market will make it difficult for importers and speculators of real estate and stock market. This approach is expected to drive the economy in a minimalist way by supporting domestic production, consumption, tourism and exports but it is uncertain until when. However, it is certain that the country can no longer enjoy import fuelled growth, and immediately needs to think of alternative paths to avert a deepening economic crisis.