Nepal foreign exchange (forex) reserves have become an important aspect of inflation control since Nepal’s economy is heavily dependent on imports. Due to a large flow of remittances and reduced imports of goods in the first half of FY 2022/23, the current account deficit dropped from 12.8% to 12.03% by 0.5% of the total GDP.
Nepal Rastra Bank (NRB) has released monetary policy for fiscal year (FY) 2023/24. It has targeted economic recovery and has emphasized price and interest rate stability, credit demand security, and external stability. The target inflation rate set by NRB for FY 2023/24 is at 6.5%. The International Monetary Fund (IMF) which previously expressed concerns regarding credit fluctuation in the financial sector has shown appraisal for the current policy. The tightening policy in FY 2022/23 has helped the economy recover post COVID-19 pandemic and global conflict effects resulting in the current policy aiming to maintain macroeconomic stability. Some of the major highlights of the policy based are listed below.
Key Policy Rates
In efforts to support credit demand and increase the lending capacities of banks, NRB has reduced the policy rate applied to commercial banks. Overnight loan rates have been lowered to 6.5%, a 50-basis points reduction from the previous rate, allowing banks to borrow funds from NRB at lower costs. The lower cost of borrowing will incentivize investments and consumption for businesses as well as individuals contributing to overall economic growth.
The total average capital-to-risk weighted assets ratio the banking sector remains at 13.1%, as of mid-April 2023 which is higher than the set regulatory minimum of 11%, indicating good financial health of banks. Furthermore, NRB has kept the policy rate for banks the same at 7.5% as it is set to maintain financial stability in the banking sector and provide liquidity to banks. The deposit collection rate has been lowered to 4.5% from 5.5%, which further reflects upon NRB’s aim to support credit demand. Additionally, NRB has set the Cash Reserve Ratio (CRR) at 4% which remains unchanged from the previous year. This minimum cash deposit requirement for Banks and Financial Institutes (BFIs) is set by NRB to establish public trust and provide protection to public deposits. The Statuary Liquidity Ratio (SLR) remains unchanged at 10% for development banks and finance companies and 12% for commercial banks. These mandatory liquidity reserves help safeguard funds providing banks with financial stability and ensure security during sudden withdrawals from banks. Moreover, NRB is also aiming to decentralize services within the financial institutions.
Foreign Exchange Reserve:
Nepal foreign exchange (forex) reserves have become an important aspect of inflation control since Nepal’s economy is heavily dependent on imports. Due to a large flow of remittances and reduced imports of goods in the first half of FY 2022/23, the current account deficit dropped from 12.8% to 12.03% by 0.5% of the total GDP. The lower deficit has allowed accumulation of forex reserves, which increased from USD 9.5 billion in mid-July 2022 to USD 10.1 billion in mid-June 2023. However, the lower imports contributed to an economic downturn as it affected most of the import-dependent business activities in the country. In the current policy, NRB is aiming to maintain forex reserves to cover seven months of imports of goods and services. The current reserves cover 9.4 months of imports which is higher than the policy floor. With the strong flow of remittance and export of electricity, a moderate imports growth due to the reserves, current account deficit is expected to narrow down to 2.8% of GDP. NRB has also increased the foreign exchange limit for Nepali travelers going abroad to USD 2,500 from USD 1,500 due to sufficient forex reserves.
Capital Market:
The risk weightage of margin loans up to NPR 5 million has been reduced to 100% from 150%, while it remains the same for loans above NPR 5 million at 150%. The changes are likely to increase investor participation in margin trading in amounts up to NPR 5 million due to low capital requirements and ease in margin lending. Altogether, this would increase participation in trading activity as margin loans are incentivized due to a lower risk weightage. Moreover, the unchanged risk weightage on loans of higher amount is an appropriate measure of risk management for banks to maintain stability in the financial marketplace amidst fluctuating price levels.
Private Sector Credit
As per data collected by NRB, lending in the country’s private sector increased by 19.4% on average in the last two decades. NRB had initially set a private sector credit growth limit at 11.5%a decrease from 12.6% from the previous fiscal year to mitigate excessive credit expansion. Nepali private sector umbrella bodies had previously expressed concerns regarding the policy and high interest rates, weak demand, unstable cash flow, low production, increasing unemployment and low confidence in the private sector. In response, NRB officials have released statements indicating flexibility in its implementation of the policy, as banks are expected to increase private sector loans up to 15%. While the private sector has been pushing to lower bank interest rates, the government must be cautious as low rates could potentially spur excessive economic growth. This could further widen inflation in the country where food prices have already increased by 7.5% (y-o-y) and non-food prices by 8.7% (y-o-y).
Housing and Real Estate:
NRB has maintained its policy on real estate with a limit of 30% of the market value for loans on real estate mortgages within Kathmandu and 40% for locations outside. After the government released the Land Use Regulation 2022, Nepal faced a heavy downturn in the real market. With the added burden of the liquidity crunch, property transactions dropped by around 56% in FY 2022/23. Furthermore, the Real Estate sector evidently plays a huge role in the Nepali economy and contributes to government revenue collection. The housing loan limit has been increased from NPR 15 million to NPR 20 million, increasing the accessibility and activity of the real estate sector. The current policy could help stabilize the real estate market, making funds more accessible to home buyers. Additionally, NRB has reduced risk weightage on residential home loans for licensed constructors to 100% from 150%.
Conclusion:
The monetary policy for FY 2023/24 has taken a well-rounded approach targeted towards economic growth. According to data from June 2023, inflation rate in Nepal decreased to 6.83% from 7.41% in May 2023. This cool down in inflation is a positive indicator of Nepal’s macroeconomic environment but it is still slightly above the current target limit. While NRB’s efforts to regulate inflation has shown some positive effects, Nepal’s economy could greatly benefit from a serious reform. As suggested by IMF, the government of Nepal should seriously consider financial and structural reforms to fight high inflation and stabilize a remittance and import dependent economy.
Nishtha Rajbhandari is an undergraduate student at Whitman College pursuing a major in Economics. Her interests lie in sustainable finance and management consulting. She is currently working as an intern at Nepal Economic Forum (NEF).