Expectations from the Monetary Policy for FY 2021/22

Monetary policy is one of the key tools used by central banks to ensure economic and financial stability within a country. By issuing the monetary policy, central banks adjust the supply of money and adjust interest rates in the market, to control inflation and manage economic fluctuations.

Delay in the Release of Monetary Policy

The Nepal Rastra Bank (NRB) typically announces the monetary policy of the new fiscal year by the first week of Shrawan (mid-July) every year. However, with the KP Oli government falling and the new government under Sher Bahadur Deuba looking to make changes in the FY 2021/22 (FY 2078/79) federal budget unveiled by the previous government through an ordinance, the monetary policy to be issued for the new fiscal year has been pushed back until the changes to the budget are announced. Considering the current economic needs of the country that has been battered by the COVID-19 pandemic, various stakeholders believe that the central bank did not have to wait for the amendment in the budget to issue the monetary policy. The monetary policy complements the budget, but it can also be an independent policy, and the notion that monetary policy is only a supplement to the budget is no longer relevant.[1] The economic sectors now have even more expectations from the monetary policy than in the past, which is why it needs to be addressed as soon as possible.

Highlights of the previous Monetary Policy

The monetary policy for the previous fiscal year (2020/21) focused heavily on economic recovery, supporting entrepreneurs and businesses to operationalize, facilitating borrowers that were hit hard by the COVID-19 induced lockdowns. It prioritized increasing investment in the agriculture sector, boosting the energy sector, and revamping SMEs affected by the pandemic.  Likewise, the NRB, along with the Ministry of Finance (MoF) announced refinancing facilities and concessional loans for businesses affected by the pandemic. Banks and Financial Institutions (BFIs) were barred from charging additional fees and penalties on borrowers and were directed not to publish any sort of auction or debt collection notice during the lockdown and up to a month after the restrictive measures were lifted.  Moreover, the third quarter review of the monetary policy also announced special refinancing loans for hospitals and industries importing/ producing medical oxygen and medical equipment/ supplies.[2] This has amped the expectations of the stakeholders from the monetary policy and the NRB needs to match the expectations accordingly for this year.

Expectations

Offsetting the impact of the second wave: After contracting by nearly 2% in FY 2020/21, the gradually recovering economy of Nepal experienced a setback once again after the second wave of the pandemic hit the country. Moreover, with the third wave impending, the country might once again go into lockdown, crushing the economy further. Therefore, the upcoming monetary policy would most likely continue programs aimed at easing monetary supply and recovery through refinancing, exercising vigilance towards financial stability. The recent inflation survey conducted by NRB estimated a possible rise in inflation. Likewise, the increase in imports by over 25% due to a rise in consumption compared to a mere 0.2% rise in exports in 11 months of FY 2021/22 resulted in a Balance of Payment deficit.[3] The new policy would need to address concerns regarding price stability and external sector stability as well. Although demand and consumption started to rise after the easing of the lockdown, the third wave of the COVID-19 pandemic would affect this. The new monetary policy should continue to support economic growth by facilitating the availability of financial instruments for increasing domestic production, job creation, and economic recovery.

Mergers and Acquisitions: In terms of BFIs, the NRB, through its previous monetary policies has been trying to reduce the number of commercial banks by encouraging big mergers by pushing up the capital requirement. The central banks believe that bringing down the number of banks is necessary to make them strong enough to fund larger projects while withstanding greater risks and compete with international banks. It would make it easier for the central bank to regulate the banks as well. The monetary policy for the last fiscal year provided various incentives for banks to go through with mergers such as the extension of the deadline for banks on priority sector lending, debenture issuance, and maintaining a 4.4% interest rate spread. It removed the mandatory cooling period of six months for promoters as well as the mandatory branch expansion approval requirement from the central bank. However, such incentives received lukewarm responses from the banks. Instead of merging, the commercial banks have mostly resorted to acquiring development banks and finance companies and have been issuing bonus shares/ right shares to meet the capital requirement. Therefore, NRB would most probably consider increasing the rate of big mergers through the upcoming monetary policy while discouraging excessive share dividends. Similarly, to prevent a liquidity crunch during this current crisis, the NRB would probably keep the cash reserve requirements for BFIs low.

Stock Market: The announcement of the monetary policy usually brings volatility to the stock market depending on how favorable or unfavorable the policy is for investors. The previous monetary raised the cap on margin lending up to 70%, increasing the flow of credit into the stock market. It also forbids BFIs with a distributable profit of less than 5% of their paid-up capital to distribute cash dividends. BFIs with distributable profits higher than 5% of their paid-up capital were allowed to distribute a maximum of 30% as a cash dividend. However, they were barred from distributing cash dividends higher than their Deposit Weighted Average maintained in June 2020. The stock market saw an incredible rise in trade volume and market capitalization over the past year, with the NEPSE Index crossing 3000 points. The central bank being wary of the bullish market, directed banks to refrain from short-term trading of stocks. Furthermore, the budget for FY 2021/22 raised the capital gain tax on short-term trading to 7.5%. So, it is likely that the upcoming monetary policy would also be less facilitative to the stock market. Nevertheless, the investors’ association has demanded that the capital gain tax be reduced to the previous 5% on short-term trading, and 2.55% on long-term investing to encourage investors.

Expectations of the Private Sector: The Federation of Nepalese Chamber of Commerce and Industries (FNCCI) also gave their suggestions to the NRB, urging the central bank to continue implementing the policies that were put in place to tackle the economic impact of the COVID-19 pandemic in the last fiscal year. Likewise, the FNCCI requested NRB Governor Maha Prasad Adhikari to prioritize SMEs and startups in the upcoming monetary policy to promote entrepreneurship while appreciating the governor for the positive effects of the refinancing facilities provided in the previous year. It was also suggested that the monetary policy should expand the flow of liquidity in the market and maintain a single-digit interest rate so that businesses would be encouraged to access credit. The previous policy ensured refinancing facilities for export-oriented and sick industries at a maximum interest rate of 3%, while SMEs were to be availed credit at a maximum rate of 5%. Similarly, commercial banks were required to extend at least 15% credit of their loan portfolio to the agricultural sector, 15% to SMEs, and 10% to the hydropower sector. The private sector expects similar provisions from the upcoming monetary policy as well.

The federal budget for FY 2021/22 envisioned an economic growth rate of 6.5%, which seems pretty farfetched considering the current situation. Nevertheless, the monetary policy needs to bring provisions that complement the goals of the budget. Unless the COVID-19 pandemic can be brought under control, the plans for economic recovery might not be as effective. This is why credit flow must be encouraged for the import, production, and distribution of COVID-19 vaccines as well as medical goods and equipment. Moreover, achieving ambitious goals such as a 6.5% growth rate would not be possible without contribution from the private sector, so the upcoming monetary policy should facilitate the recovery and growth of the private sector through various stimulus packages, refinancing facilities, and concessional loans that are not only limited in the paper but are also implemented without bureaucratic hassles.

[1] https://www.abhiyandaily.com/newscategory-detail/391043

[2] https://www.nrb.org.np/contents/uploads/2021/05/MP-2020-21-3rd-Quarter-review-final-document-2078-2-4.pdf

[3] https://thehimalayantimes.com/business/nepal-registers-bop-deficit-of-rs-1515bn