The key question for NRB is, “What should be the monetary policy stance towards both financial sector stability and growth objectives?"

--BY AR BHATTARAI

Despite several severe shocks in the past such as conflicts, unstable governments, earthquakes, and trade disruptions, Nepal has made strong progress in reducing poverty and boosting shared prosperity. The government is keen to accelerate economic growth and become a middle-income country by 2030. Investment needs are quoted at 10-15 percent of GDP annually in the next decade, and they will require timely and appropriate solutions. The government recognises the magnitude of the infrastructure gap and the urgency of addressing it.

Before the Covid-19 pandemic, Nepal had maintained its robust growth performance. Remittances remained buoyant. Crops had bumper harvests. Overall inflation slowed as decelerating food inflation offset a pickup in non-food inflation. Higher import and lower export growth increased the current account deficit, at the same time due to Covid-19, it is expected that remittance is likely to fall significantly and the decline in remittance will further increase the current account deficit and put pressure on the overall balance of payments. As Nepal heavily depends on remittance to fund imports it is more vulnerable to the adverse macroeconomic effects of the pandemic.

The monetary policy has been successful in maintaining the money supply and has supported the government growth objective. However, vulnerabilities in the banking system and capital market have persisted as the private sector credit growth overshot the target for the last several years. Moreover, due to Covid-19 private sector credit growth slowed during the current fiscal year.

A stronger emphasis on private sector participation in green recovery could increase efficiencies by introducing private sector management expertise, technologies, and competition, and by transferring risks.

Key structural challenges of Covid-19 are to mitigate the financial sector vulnerabilities, strengthen revenue mobilisation, manage public investments better, meet the infrastructure gap, enhance human capital and streamline business regulation. Low revenue collection will be a major challenge. Addressing these challenges will be critical for reinforcing future productivity growth.

With large financing needs, large debt burdens and a widening trade deficit are particularly vulnerable to a sharp increase in borrowing cost and limited access to finance. Though Nepal still enjoys relatively low debt-to-GDP ratio however, meeting the required resources will be a challenge. The budget deficit will increase in FY2020/21 and it will be more than 5 percent of GDP

The Covid-19 pandemic has struck a devastating blow to the Nepali economy. Lockdowns and other restrictions, together with spontaneous reductions in economic activity caused significant negative impact. Demand for goods and services has been severely curtailed, while at the same time supply has fallen sharply, as the number of people working has declined and the cost of doing  business has risen. The shock has caused unprecedented disruptions to trade, travel, and tourism, as well as stress in financial markets. Labour supply has declined because of restrictions in movement. Investment has also been curtailed due to weaker growth prospects, rising financing costs, eroding confidence, and increased uncertainty.

Since the outbreak of the coronavirus, there has been a general feeling that nothing will ever be the same again. Therefore, the key question for NRB is, “What should be the monetary policy stance towards both financial sector stability and growth objectives?"
1.    Identify the challenges faced by the economy.
a.    Short-term growth impact of the pandemic
b.    Long-term growth implications of the pandemic

2.    To understand these challenges NRB should sensibly access:
a. Sufficiency of assessment of impact on the economy during the pandemic and response to reduce economic shock.
b. Adequacy of economic recovery plan required for bouncing back to improving business confidence and increasing employment and improving productivity.
c. Identifying emerging threats to financial stability.
d. Adequate liquidity for economic recovery plan that can reduce the cost of recovery.

3.    Implement monetary policy to minimise the impact of the Covid-19 pandemic.
    The recent focus by regulators and supervisors on operational resilience is aimed at ensuring the ability of firms and the financial system as a whole to identify, detect, protect, adapt and respond to, as well as recover and learn from, operational disruptions. Therefore, NRB must take regulatory measures to mitigate the burden of debt servicing brought about by disruptions on account of the Covid-19 pandemic and to ensure the continuity of viable businesses. In this regard, it is recommended that the monetary policy should:

1.    Risk Assets Management.
a.    Allow rescheduling of payments - Term loans and personal loan facilities BFIs should be allowed to provide an appropriate moratorium period for repayment of interest and principal along with interest capitalization without additional provisioning and the same shall not be treated change in terms and conditions of loan agreements. The rescheduling of payments, including interest, will not qualify as a default for the purposes of supervisory reporting and reporting to the Credit Information Bureau (CIB) by the BFIs. BFIs Board shall provide blanket authority to CEOs for providing relief to all eligible borrowers.

b.    Fall in remittances and economic recession is likely to lead to an increase in non-performing loans. Therefore, temporary relaxation of asset classification and provisioning norms or refinancing of stressed assets will help BFIs to maintain commercial banks' aggregate capital adequacy ratio (CAR).

c.    Ease working capital financing and margin lending.
    In respect of working capital facilities and margin lending to borrowers facing stress an account of the economic fallout of the pandemic, BFIs may review the 'drawing power' by reducing the margins and/or by reassessing the working capital cycle. BFIs Board shall provide blanket authority to CEOs for providing relief to all eligible borrowers.

d.    Capital charge for past dues should be reduced for the next two years.

e.    Allow assets purchase and allow peer-to-peer lending and invoice discounting.

f.    Review assets and liability pacing policy. Most of Nepali banks do not use systematic approach to pricing, the pricing function is fragmented and there are no meaningful guidelines disseminated.

g.    Review inventory certification as Covid-19 may have created many uncertainties about the likely future scenarios which may affect the valuation of inventories.

h.    Review base rate calculation method to include all costs.

i.    Allow use of management certified balance sheet for corporate clients and relax debt equity ratio/loan to value ratio and loan to income ratios for the next one year.
j.    Due to Covid-19 there is general deterioration of the operating environment and customer risk profile and reduction of risk appetite, prompted by the tightened capital adequacy requirements, therefore, NRB should increase coverage of credit guarantees on MSME loans to build up confidence to lend.
k.    Residential mortgage threshold to be increased and risk weight for suchmortgages (home loans) should be reduced.
l.    Review the provision to limit the debt service to Gross Income Ratio (DTI) for the instalment-based non-business loans such as personal loan, home loan, hire purchase loan and others at least for the next two years.
m.    Support innovation in financial products to reach under-served market segments and strengthen competition and market effectiveness in the financial sector.

The operational focus should be on projects that contribute to:
i.    Economic inclusion
ii.    Access to finance of underserved customer segments, particularly MSMEs
iii.    Development of financially sustainable forms of investment in energy efficient production and green recovery
iv.    Transfer of skills, investments in technology or innovative products or processes.
n. Implement mandatory taking Permanent Account Number (PAN) for all size loans.

2. Liquidity Management.
a.    Diversifying/expanding the financial sector through financial inclusion.
b.    Fall in remittances is likely to constrain availability of foreign currency in the economy. Hence, non-essential imports may be reined in to ease the pressure on the existing stock of foreign exchange reserves.
c.    Replace CCD ratio by Net Liquidity Ratios, Maintain Net Liquidity Ratios at 15 percent.
d.    Lower reserve requirements and the interest rate on the standing liquidity facility. While NRB has already lowered its cash reserve ratio from 4 percent to 3 percent and reducedthe interest rate on the standing liquidity facility rate to 4 percent, it may further inject long-term liquidity in the system by conducting long term repo auctions.
e.    Review the policy restricting BFIs to collect not more than 10 percent of their total domestic deposit liabilities from single depositor and limit for total institutional deposit of 50 percent.
f.    To improve liquidity at system increase interbank lending period from 7 days to 21 days.
g.     Discourage cash dividend for next two fiscal years to build up a strong capital base and liquidity.
h.    Introduce long-term repo operation and increase the tenure of interbank lending.
i.    Review the policy requirement of 'A’ class commercial banks to issue debentures of at least 25 percent of their paid-up for the next fiscal year.
j.    Discourage cash transactions and promote electronic payment system by focusing on digitization & Fin-tech and reduce cost of transaction.
k.     Take appropriate steps to generate unique identification numbers for each individual used for opening bank accounts and taking loans.

3.    Foreign Reserve Management.
a.    Allow BFIs to access offshore finance: Ensure provision for BFIs to mobilise resources both deposit (short-term and long-term) and debts from abroad in foreign exchange from institutional depositors and non-resident Nepalis and continue to allow 100 percent of such deposits for extending loans in Nepali currency.
b.    To maintain credibility of exchange rate, peg review foreign exchange policy by maintaining adequate reserves at least for eight months.
c.    Restrict non-essential imports.
d.    Review forex regulation to amend provisions relating to investment, repatriation, investment of, lending and borrowing in foreign exchange.
e.    Initiate steps to harmonise the provisions of Foreign Exchange (Regulation) Act, 1962 and The Foreign Investment and Technology Transfer Act, 2019.
f.    Take necessary steps towards capital account convertibility
g.    NRB shall promote “blended finance" and implement hedging mechanism.

4. NRB should direct all BFIs to separately calculate their Net open position of INR and other foreign currencies.

5. Provide flexibility to BFIs to fix interest rate on foreign currency denominated loan.

6. Merger and Acquisition.
a.    Development of a sound banking sector through improvement of business standards, restructuring and consolidation, and increased competition.
b.    To encourage mergers,the following facilities should be provided to BFIs
i.    The deadline to meet the credit requirements for agriculture, energy and tourism sector needs to be extended to mid July 2022.
ii.    The deadline to reduce the spread between lending and deposit rates needs to be extended till mid July 2022.
iii.    No approval requirement for opening and closing branches.
iv.    The existing provision of a cooling period of six months should not be applicable for the members of the board of directors, chief executive officer and deputy chief executive officers while joining other institutions licensed by this bank.
v.    The deadline to issue debentures worth 25 percent of paid-up capital needs to be extended to mid-July 2022.

7. Legal Reform.
a.    Assist with better governance, more sustainable business models and improved risk management of banks and non-bank institutions.
b.    Strengthen or reform the legislative framework, especially around effective functioning of financial sectors and local currency / local capital markets development.
c.    Review BAFIA to strengthen State Owned Bank (SOBs) and recapitalise them either by injecting fresh capital or by consolidating with or acquiring a few private banks to increase the balance sheet site at least to USD 3 billion to attract foreign institutional investors.
d.    Take appropriate steps for full implementation of the Secured Transaction Act 2006 with an aim to align with the 2016 UNICTRAL model law on Secured Transaction.
e.    Initiate steps for enactment of Credit Information Act to support a better environment for finance sector reform in areas such as enhanced credit information, better financial news reporting.
f.    Merger strategies did not bring the much-needed change to the ownership, governance structuretherefore, to increase transparency in the financial sector; NRB should implement strategies to limit the presence of borrowers on the bank's board.
g.    Support implementation of a legal provision relating to Human Resources Audit.
h.    Initiate steps for enactment of Offshore Banking Act to improve access to international market and Assets Management Company Act to manage assets quality of BFIs.
i.    Implement separate policy to supervise systematically important bank and in light of COVID-19 modify manuals and modalities of inspection and supervision activities.
j.    Support regulation and inspection of non-bank financial institutions and develop a framework for private equity and venture capital in coordination with SEBON to strengthen the financial sector by achieving better diversification (including the development of the non-banking sector) and integration into global financial markets.

8.    Green Recovery.
a.    Boost climate-smart infrastructure and avoid carbon-intensive investments.
b.    Support Development and adopt climate-smart technologies.
c.    Promote Energy Efficiency (EE) financing by including EE in productive sector.
d.    Promote zero-emission vehicles to support the development of clean fuels for transportation.
e.    Implement environmental standards without relaxation.
f.    Monetary policy should support the transition to a healthier, resource efficient green and circular economy, founded on sustainable consumption and production patterns anchored to sustainable value chains.

9.    MSMEs.
a.    Monetary Policy should support MSMEs to generate income and employment for workers along with promoting decent work including in essential services, which are needed to avoid disruption and permanent job losses. To do this NRB should mandate at least 25 percent of total portfolio to these sectors.
b.    Interest-rate subvention for working capital loans to MSMEs, temporary increase in Loan to Value (LTV) and Loan to Income (LTI) ratios will provide the needed boost.
c.    Initiate steps to have single definition of MSMEs across all regulators and develop new guidelines for MSME.
d.    Introduce policy to scale-up agriculture base MSMEs, which can immediately create employment.
e.    Introduce E-commerce and digital solutions to increase access to short-term bridge loans to micro and small businesses, and digital payments.
f.    Waive penalties for default of small companies, one person company, producer companies and start ups

10.    Capital Market.
a.    NRB should support the development of capital markets as it is essential for the capital market infrastructure to align with the banking system.
b.    Review regulatory framework with the view of removing or smoothing out the impediments that have so far prevented this market from developing to full potential.

11.    Others.
a.    Continue strengthening goAML system to prevent money laundering and combating financing of terrorism activities.
b.    Review branches opening and closing policy.
c.    Start sectorial analysis and take steps to make rapid assessment of BFIs to understand long-term impact of Covid-19.
d.    Ease imports of medical equipment including but not limited to artificial respiration or other therapeutic respiration apparatus (ventilators), face masks and surgical masks,personal protection equipment (PPE), Covid-19 testing kits.
e.    Revisit operational strategies of BFIs without having impact on access to finance.
f.    Installation of fully integrated Management Information System.

Bhattarai is a chartered accountant and former banker.