The Monetary Policy 2018/19 is fairly well-balanced to accommodate the fiscal policy with the expansionary measures for credit creation and interest rate stability.

--BY HOM NATH GAIRE

A monetary policy is an institutional mechanism which regulates the supply of money, or liquidity, in the economy in order to achieve desired policy goals. 

However, the central banks have been allowed to choose from the policy goals depending on the need of the economy, a suitable environment for implementation and the available policy instruments as well as indicators. In this regard, Nepal Rastra Bank (NRB), the central banking authority of Nepal, has a greater operational independence in the conduct of monetary policy provided by the NRB Act 2002. The Act has mandated NRB to play an important role in the country’s economic development by promoting economic growth and ensuring price stability. 

This article will attempt to analyse the Monetary Policy for FY2018/19 recently unveiled by NRB. The provisions introduced for the first time in the monetary policy and the major revisions from the previous policies have been highlighted. Economic changes and impacts expected from the policy will also be discussed in
this article.  

Policy Direction
NRB has clearly indicated that the Monetary Policy for FY2018/19 would be expansionary and aims to accommodate the fiscal policy announced by the federal government one and a half months ago. The central bank is hopeful that the monetary policy will help to achieve the economic growth target of 8 percent set for the current fiscal year while limiting the inflation rate to 6.5 percent. These goals are broadly in line with the mandate of the NRB Act while devising the monetary policy.

Considering the government's aspirations for high economic growth and resulting demand for the investible fund in the banking system, NRB has reduced the Cash Reserve Ratio (CRR) – the minimum cash deposit that the banks are required to maintain at NRB – by a maximum 200 basis points. Similarly, the Statutory Liquidity Ratio (SLR) has also been reduced by the same rate for all categories of financial institutions. Such a huge reduction in CRR and SLR would increase the monetary base and increase the lending capacity of the banking system by almost Rs 50 billion. 

According to the current values of deposit expansion multiplier and money multiplier, the additional money released from the central bank's coffers to the banking system would enable the banks and financial institutions to create a fresh credit of around Rs 200 billion. If mobilised in the productive sectors, this money would generate economic activities of around Rs 500 billion within the country. Thus, if implemented effectively this policy would help to realise the fiscal policy's targets in economic growth and inflation. 

Investment promotion
The demand for long-term loans has been increasing particularly due to the increasing activities in large projects such as hydropower, connectivity, manufacturing and tourism. In the meantime, the acute shortage of funds in the country's banking system has held back BFIs from mobilising capital in such long-term projects and has created interest rate instability, ultimately discouraging the investors and leaving them confused about the commercial viability of the planned projects. 

To address the issues related to the shortage of investment-grade money, NRB has introduced a few policy measures aiming to expand the base of the investible fund in the banking system. First, the banking sector regulator has opened the door for BFIs to attain loans of up to 25 percent of their primary capital in the Indian currency too. Earlier, the provision was applicable only to convertible foreign currencies other than the Indian currency.

NRB has now maintained a similar provision for microfinance institutions. Similarly, the policy has allowed commercial banks to raise money from the domestic market issuing debt instruments (debentures/bonds) and permitted it to be counted as deposits while calculating the credit-to-core-capital-cum-deposit (CCD) ratio. The CCD level, which is currently set at 80 percent, has long been a matter of debate as a policy tool. The bankers have been demanding to either abolish or increase it while the central bank was not ready to meet their demand in this regard. Now, at least, the issue has been partially addressed, though its effectiveness is yet to be seen.  

Apart from introducing new policy measures, the central bank has continued with the existing ones. However, some of the provisions have been revised so as to facilitate the additional credit liquidity in the system and in turn to expand the credit to the productive sectors.

First, by maintaining the minimum threshold of loans to be extended to the priority sector at 25 percent, NRB has asked commercial banks to provide at least 10 percent of the loans to the agricultural sector and 15 percent to energy and tourism. The limits for development banks and finance companies in the priority sector have been kept unchanged at 15 percent and 10 percent respectively.  Although the limit given to the energy and tourism sectors is not enough to meet the growing demand in the sectors, the private sector has welcomed this provision in the monetary policy. 

Another welcome step is the increment in the size of the refinancing fund by 75 percent from Rs 20 billion to Rs 35 billion. Although this expansionary move in the monetary policy is expected to address the growing demand for loans in the manufacturing and export-oriented industries, the industrial sector (the target group of this fund) are not to be satisfied as the industrialist have been asking the NRB to increase the time limit of refinance which is just 2 years at present.

Interest Rate Stability 
The monetary policy for the FY 2018/19 has attempted to address the issues related to the interest rates that have been constantly rising in recent months. The skyrocketing and unstable interest rates have been a headache for bankers as well as businesses. The issues have been partially addressed by narrowing down the interest rate corridor and reducing the bank rate at which the BFIs borrow money from the central bank as a type of last resort.
The squeezed interest rate corridor would maintain the short-run interest rates within a limited range restricting them to more volatility and uncertainty. As the short-run interest rates signal the situation of long-run deposit and lending rates, it is believed that the long-run rates also will not go beyond a certain range. This should help maintain interest rate stability to some extent allowing the businesses to predict their costs of capital at least for the near future.   

The policy has aimed to reduce the spread rate, the average difference between the deposit rate and lending rate, to 4.5 percent from 5 percent. But there are concerns whether it can be implemented effectively as such spread rates often used to be higher than the ceiling fixed by the central bank. However, at least theoretically, it implies that a bank would not be allowed to charge interest on credit higher than 4.5 percent of its average deposit rate. On the one hand, the central bank is enabling BFIs by releasing additional money to the system and on the other urging them to bring down the interest rate spread than before. It can be helpful in controlling the upward pressure on lending rates which would reduce the economic risks associated with the unpredictability of interest rates. 

Financial Sector Stability
Additionally, the policy has also aimed to maintain discipline in the financial system and expand people’s access to financial services. As per the new provision, commercial banks do not have to take permission from NRB to open branches in locations outside metropolitan and sub-metropolitan cities. The central bank has raised the deposit guarantee limit to Rs 300,000 from the existing Rs 200,000.

In the meantime, NRB has also reduced the limit of overdraft on individual loans from Rs 7.5 million to Rs 5 million. The reduced overdraft limit is expected to increase loans in the productive sector, which may help create more economic activities and employment as well as more income for people. With the aim of building the confidence of those foreign investors who are willing to put their money in Nepal, NRB has introduced the idea of hedge funds for the first time in Nepal. In this regard, the central bank itself has taken the responsibility of operating the hedge fund and managing the forex risks associated with the foreign capital.

The author is a Ph.D candidate in Economics at Tribhuvan University.