- NewBiz Report

At a time when the Nepali economy is struggling to come out of the deep recession, the Nepal Rastra Bank (NRB) has come up with the Monetary Policy for FY 2024/25 garnering wider attention from the stakeholders of the country's economy. After three consecutive years of tighter monetary policy, the central bank this time has eased the policy arrangements seemingly to please the disgruntled private sector and the political leadership who were demanding NRB take a lenient approach to end the economic sluggishness. NRB found itself under a considerable pressure after the formation of a new government, the appointment of Bishnu Paudel as Finance Minister, and the growing demand of the private sector for monetary stimulus. 

When NRB Governor Maha Prasad Adhikari finally unveiled the 2024/25 monetary policy on July 26, it became clear that the central bank had succumbed to the pressure and expectations. In his last monetary policy speech as the NRB governor, Adhikari sounded accommodative contrary to his past unobliging stance, much to the satisfaction of both the political class and the private sector. While unveiling the policy, Adhikari said that the central bank has continued its agenda of a ‘cautiously accommodative’ monetary policy to 'make the economy vibrant'. 

After assuming the post of NRB governor in April 2020, Adhikari facilitated credit expansion in his first monetary policy (FY 2021/22) speech by providing substantial refinancing and working capital loans to borrowers with a view to providing monetary stimulus to the Covid-stricken economy. While businesses continue to seek similar support, it appears Adhikari has learned from past experiences and adopted a more balanced, cautious approach.

Governor Adhikari's cautious approach acknowledges the limitations of monetary policy alone in stimulating demand if internal economic conditions remain stagnant. He has highlighted the need for effective fiscal policies and reforms to achieve long-term economic improvement and financial stability. "Maintaining short-term ease through monetary policy poses a challenge to achieving long-term financial stability," he remarked.

However, there are concerns that the new policy may not adequately address persistent issues within the financial system, such as misuse of credit and excessive debt accumulation. Despite previous promises, significant reforms, including a single credit limit policy, remain unaddressed.

One of the central elements of the new policy is the reduction of key rates. The NRB has lowered the policy rate from 5.5% to 5% and the bank rate from 7% to 6.5%. These adjustments are intended to reduce borrowing costs for banks and financial institutions, thereby making credit more accessible and stimulating economic activity.

Additionally, the central bank has set an ambitious credit expansion target of 12.5% for the current fiscal year, up from last year's target of 11%. The central bank has also lowered the upper limit of the interest rate corridor from 7% to 6.5%. This adjustment is expected to result in a reduction in interest rates.

This target is part of a broader strategy to invigorate the economy, which has struggled with low growth rates despite previous high credit expansion. Historically, credit has grown at an annual rate of 20% over the past three decades, yet economic growth has remained around 4%, highlighting a disconnect between credit availability and economic performance.

Adhikari's final monetary policy as the NRB governor reflects a blend of generosity and caution. While the NRB has relaxed several regulations to encourage lending, there is a clear intention to avoid reckless credit expansion. Adhikari has termed this approach as "cautiously flexible," balancing the need for increased credit with the imperative to manage economic risks.

After the Covid-19 pandemic, the NRB had adopted a flexible monetary policy leading to rapid credit growth. However, this expansion introduced new risks, contributing to a weakened economic outlook. The International Monetary Fund (IMF) has noted the detrimental effects of expansive credit policies on Nepal's economy.

Despite the availability of excess liquidity in the banking system, stagnation in credit expansion and surge in non-performing loans have troubled the banks and financial institutions. According to the central bank’s data, the credit expansion to the private sector from Banks and Financial Institutions increased by 5.1% year-on-year in the first 11 months, until mid-June, in the last fiscal year. The credit expansion growth target for the last fiscal year was 11.5%. Similarly, the overall non-performing loans ratio was 3.98 in the first nine months, until mid-April, of the last fiscal year.

Bank Rate and Policy Rate Lowered

The NRB's recent decision to lower both the bank rate and the policy rate signals its intent to reduce the cost of borrowing for banks and financial institutions. However, given that these institutions currently have ample funds, they do not necessarily need additional loans from the central bank. Typically, the NRB adjusts the bank rate and policy rate to influence interest rates: increasing them to raise borrowing costs and decreasing them to lower borrowing costs.

Instead of relying solely on monetary tools, the NRB has introduced various regulatory measures to support financial institutions. Notably, the NRB has advanced a facility to address the capital shortfalls of banks that have overextended their lending capacities, which is expected to boost credit availability.

The loan loss provision for good loans has been reduced from 1.2% to 1.1%, potentially increasing bank profits by approximately Rs 5 billion. Furthermore, the regulatory retail portfolio limit has been raised to Rs 25 million, which eases capital requirements for banks and facilitates greater lending.

The policy also introduces greater flexibility for businesses with working capital loans. Borrowers now have until mid-July 2025 to adjust loans that exceed their limits. This extension is designed to support businesses in managing their debt more effectively.

Sunil KC, CEO of NMB Bank, said that the new monetary policy has tried to identify and address the issues in the overall economy. “It gives the positive vibe to support the vibrant economic activities,” said KC, who is also the president of the Nepal Bankers’ Association. “But, monetary policy has its own limitations.”

Relief to the construction sector

The construction sector has been a focal point of the new policy. Recognizing the sector's unique challenges, especially in light of government payment delays, the NRB has extended the interest payment period for construction loans until mid-December 2024. Contractors who had previously faced blacklisting due to check dishonor are now granted reprieve, and provisions are made to prevent the blacklisting of joint venture partners based on the actions of a single partner. Should the Government of Nepal extend the construction period, arrangements will be made to renew the guarantees provided by banks and financial institutions.

The construction sector has also welcomed the new monetary policy. Rabi Singh, President of the Federation of Contractors’ Association of Nepal (FCAN), highlighted that, in addition to external factors, the lack of government payments has worsened the situation for contractors. “The government still owes us around Rs. 60 billion for completed projects,” Singh said.

One of the central elements of the new policy is the reduction of key rates. The NRB has lowered the policy rate from 5.5% to 5% and the bank rate from 7% to 6.5%. 

Singh noted that the new monetary policy has made an effort to address their issues. “Our demands have been the same when the NRB was formulating the monetary policy for fiscal year 2021/22,” Singh said. “While we welcome these measures, they offer only a temporary solution.”

While contractors have welcomed the new monetary policy's measures aimed at the construction sector, economists remain skeptical. Economist Keshav Acharya argues that the central bank's actions were influenced by the government's budget failing to revitalize the economy. "It caused everyone, including the private sector and traders, to place their hopes on the monetary policy," he said. “For the first time, the central bank has focused so heavily on the construction sector in its monetary policy.” Acharya contends that the policy has strayed from its core objectives. “It should have concentrated on ensuring financial stability to create a conducive environment for investment,” he said. “Instead, it seems to be viewed as a policy primarily aimed at expanding credit to the private sector.” Acharya also noted that the economic cycle, already disrupted by the Covid pandemic, was further strained by the previous monetary policy, which injected over Rs 200 billion into the market as refinance facilities during the pandemic.

“Despite the significant growth in credit expansion, the funds were invested not in productive sectors but in speculative areas such as the stock market and real estate,” Acharya added. “What guarantee is there that the credit expansion envisioned by the new monetary policy will be directed towards productive sectors?”

The central bank has removed the previous maximum limit of Rs 200 million on margin loans for institutional investors, allowing banks and financial institutions to provide larger loans. This change opens up greater opportunities for institutional investors. Although no additional flexible arrangements, such as those sought by share individual investors, have been announced, this adjustment is expected to enhance investor confidence in the stock market.

Establishment of AMC 

While the talks to establish an asset management company (AMC) dates back to 2000, the central bank for the first time has announced to start work to set up such an entity in order to face the challenges presented by the massive surge in bad debts in the country’s banking system. Governor Adhikari stated that a draft of the Asset Management Act will be prepared and submitted to the government. The proposed entity will focus on managing non-banking assets and non-performing assets of banks and financial institutions. In response to the increase in bad loans, the central bank has advocated for this new structure to better address these challenges. 

The central bank has removed the previous maximum limit of Rs 200 million on margin loans for institutional investors, allowing banks and financial institutions to provide larger loans.

Meanwhile, NRB will begin developing the design characteristics of a wholesale Central Bank Digital Currency (CBDC), drawing from studies of central bank electronic currencies. Governor Adhikari also announced that preparations will be made for the necessary infrastructure and institutional framework to fully operationalize the National Payment Switch.

Notably, the policy has not addressed reforms such as implementing a single credit limit policy to prevent excessive debt accumulation by a few entities. Credit abuse remains a major issue within the financial system. Despite the central bank's acknowledgment of the trend of misusing loans—where funds intended for enterprise businesses are diverted into real estate and shares—a clear policy to address this issue has not been presented.