Nepal Rastra Bank has started preparing the Monetary Policy for the next fiscal year amidst the financial devastation caused by the second wave of Covid-19 pandemic. Praise was heaped on the central bank in the current fiscal year for producing what many called a ‘pro-business’ monetary policy aimed at providing relief to borrowers who saw a sharp reduction in their cash flows. The central bank must give continuity to schemes launched in this fiscal year. Going forward, it must expand the size of the refinancing facility and the scope of the credit restructuring scheme to encompass many more businesses.

The central bank had greater leverage this fiscal year, as the balance of payments (BoP) did not come under extreme pressure for most of the year despite the loss in tourism income and downfall in foreign direct investment, as remittance income continued to go up and import growth remained tepid till the first half of the fiscal year due to lower demand for consumer goods.

Since the inflow of money to the economy exceeded the outflow, interest rates of banks remained somewhat stable. But the situation is rapidly changing. The BoP surplus dropped to Rs 7.8 billion in the first 10 months of the current fiscal year as against Rs 120.9 billion in the same period a year ago. This is a tell-tale sign of rapid acceleration in the outflow of money from the country.

A deceleration in BoP surplus reduced the size of foreign exchange reserves to USD 11.9 billion in mid-May, as against the all-time high of USD 12.8 billion recorded in mid-January. The stock of foreign currency is sufficient to finance the imports of goods and services for 10 months, so there is no need to panic. But the BoP is likely to slip into negative territory soon, as income from foreign tourists is unlikely to grow in the coming days. The tourism sector generated Rs 75.4 billion in foreign currency in the fiscal year 2018-19 and fell to Rs 60.9 billion in the last fiscal year as lockdowns were clamped in March 2020 to contain the spread of Covid-19. Tourism income has further plunged this fiscal year, standing at a mere Rs 6.2 billion in the first 10 months of 2020-21.

This situation is unlikely to improve in the next fiscal year as well, as foreigners will continue to avoid Nepal unless vaccines are rolled out rapidly. Without a sharp spike in tourism income, revenue generated through remittances and merchandise exports will not be sufficient to finance merchandise imports, which has been growing rapidly after the first half of this fiscal year and will continue to grow in the next fiscal year considering the reduction in taxes of electronic appliances and electric cars made in the fiscal policy for 2021-22.

What is likely to exacerbate the problem is a drop in foreign direct investment. Although the central bank has introduced favourable policies, such as the abolishment of the provision to seek its permission to bring in foreign investment of up to USD 1 million to facilitate foreign investors, Nepal is unlikely to reap the benefits from these changes immediately as amendments need to be made to other related legislations. Also, FDI has been on a decline globally, as the pandemic is not over yet.

If BoP continues to feel the pressure, lending rates of banks may rise in the next fiscal year, dealing a blow to enterprises seeking to revamp production through bank credit. Unless enterprises get loans at affordable interest, economic growth, which stood at a negative of two percent in the last fiscal year, will not jump to 6.5 percent in the next fiscal year as envisaged by the fiscal policy for financial year 2021-22. Expensive credit will also generate inflationary pressure, making goods expensive.

Price levels are already very high in Nepal compared to other countries in South Asia, which is why the minimum wage in the country is the highest among South Asian nations. A further jump in prices will only make matters worse. This calls for a monetary policy that can keep prices and interest rates at a lower level. Globally, central banks make use of policy rates to tame prices and short-term interest rates. But policy rates have never worked in Nepal. This means the central bank should restructure its interest rate corridor so that it could deliver better results. It should also address the problems faced by the tourism and transport sectors, which have been badly hit by the pandemic, while providing relief to micro, small and medium enterprises that create a big chunk of jobs in the country.

Madan Lamsal
madanlamsal@gmail.com