Key Highlights of Nepal’s Monetary Policy for FY 2024/25

Nepal Rastra Bank (NRB) unveiled its monetary policy for FY 2024/25 on July 26, 2024. Its main objectives are to help achieve the government’s 6% economic growth and 5% inflation targets, provide adequate liquidity for borrowing and lending, and incentivize investment in the productive sectors of the economy. Many economies have started loosening their monetary and fiscal policies as they gradually move back on track after the setbacks of the pandemic. This is the case with Nepal as well. After a few years of a relatively tight monetary policy aimed at economic recovery, NRB has introduced an expansionary monetary policy designed to stimulate demand and drive economic growth.

Forex

After the 2022 foreign reserve debacle, the status of the foreign exchange reserve has been a critical policy concern. Due to a consistent flow of remittances, import restrictions, and reduced domestic demand for foreign goods, Nepal’s foreign exchange reserve is currently in a robust position with the capacity to handle more than 12 months of import. However, Nepal’s fiscal space has seen a problem recently, with expenditures consistently surpassing revenues. To ease pressure on the fragile government treasury, NRB has lifted import restrictions to collect revenue by taxing imports. The foreign reserve target for this fiscal year is to have the capacity to handle seven months of import. The central bank has also increased the facility limit for importing goods through draft/TT from USD 35,000 to USD 50,000. Similarly, the limit for imports through Document Against Payment and Document Against Acceptance has been increased from USD 60,000 to USD 100,000. This will enhance import capacity and expand trade through imports giving the government greater possibilities of earning revenues through tariffs. The policy also aims to provide some relief to people traveling abroad by easing the process and limitations of gaining foreign currency, although it is very unclear.

Driving Liquidity through Loans

Addressing liquidity concerns in the banking and financial institutions, a strategy has been taken to reduce the risk burden and encourage credit demand in the private sector to facilitate liquidity flow while reducing the pressure of capital funds on banks and finance companies. The central bank has worked to open the doors of all-round investment through monetary policy. The upper ceiling of the Interest Rate corridor has decreased from 6.5% to 7%, and the policy rate has reduced from 5.5% to 5%. While the lower ceiling of the corridor is kept at 3%, the monetary policy has shown expansionary signs that are likely to propel the previously sluggish aggregate demand. For the financial year 2024/25, the growth rate of the broad money supply is projected to be 12%, and the growth rate of credit to the private sector is projected to be 12.5%, up from 11.5% last year. The limit of the Regulatory Retail Portfolio is increased from NPR 20 million to NPR 25 million. This change is designed to offer greater flexibility and capacity for managing retail assets, support financial institutions, and increase investment opportunities in the retail sector by providing adequate liquidity.

The monetary policy has also managed to please investors in the share market. NRB has made provisions to end the NPR 200 million limit on share collateral loans to institutional investors. This change aims to enhance investment flexibility and boost the confidence of people wanting to invest in the stock market, increasing overall investment and benefitting the wider economy.

According to the Central Bank, the loan limit of NPR 10 million set for micro, domestic, small, and medium enterprises will be reviewed. It has stipulated that the interest cannot be determined by adding more than a 2% premium to the base rate for loans to micro, small, domestic, and medium enterprises valued up to NPR 20 million. The policy has also arranged to provide loans against agricultural produce and encouraged investments into startups attempting to incentivize borrowing, making it accessible to the general public wishing to invest in a productive sector.

Revised Regulations for Banks and Financial Institutions

The Capital Adequacy Framework, established to regulate Banks and Financial Institutions (BFIs), will be reviewed and updated according to international standards and practices. To resolve the country’s cooperative fiasco, the NRB has taken measures to ensure that depositors with blocked funds in cooperatives can recover up to NPR 0.5 million. The policy also encourages the mergers and acquisitions of Microfinance institutions and their branches to strengthen regulation. The monetary policy has also introduced provisions for a contemporary review of the regulatory arrangements concerning interest rates on loans and service charges imposed by microfinance institutions. Additionally, it includes measures to reschedule loans for customers unable to make payments due to their circumstances, provided they pay a certain percentage of the interest. It even states that additional measures will be implemented to encourage microfinance institutions that operate within a specific province or locality. To improve bank profitability, the monetary policy has reduced the provision for good loans from 1.20% to 1.10%.

Eased Blacklisting Regulations for Private Sector

The private sector has been excited ever since the announcement of the monetary policy. Particularly, the construction sector, which had been facing negative growth for the past 2 years, is very optimistic about the policy changes that the central bank has made. Due to a delay in the payment from the government authorities, limited income this financial year, and strict banking regulations, NRB has extended the payment period for construction companies to December 2024. Moreover, the policy has attempted to address the high number of construction companies being blacklisted by easing rules and policies in their favor. For instance, it has removed the mandate of being blacklisted just because a business dishonors a cheque. This will likely ease financial pressure on the businesses and prevent them from facing the repercussions.

Going further, NRB has made arrangements not to affect any joint venture partners if one of the partners ends up being blacklisted. This will increase joint venture confidence and encourage businesses to work together and achieve greater synergies. Similarly, if private equity and venture capital firms happen to invest in a company that later becomes blacklisted, then those investment companies won’t be affected or blacklisted.

Limitations

The stance NRB has taken towards foreign reserves is debatable. The recent increase in reserves, rather than being driven by increased domestic productivity or exports, comes from remittance, increasing tourists, and prevailing import restrictions. This makes it unlikely that the reserve will be sustainable. After relaxing import restrictions without increasing domestic production, it might not take long for the economy to regress to crippling forex reserves with sources of foreign currency remaining unpredictable.

NRB has decreased interest rates to drive up business activity in the past, similar to the Monastery Policy for FY 2024/25, which has failed to make much impact. A reason for this could be the gap of translating it forward to the borrowers and lenders. Recently, the banks are reluctant to lend due to a lack of credible borrowers and strict lending and borrowing policies and there has been a lack of demand due to decreased business confidence, which has led to increased liquidity with the banks. Amidst this systemic problem, the decision to reduce good loan provisions from 1.20% to 1.10% might be counteractive and expose BFI’s to greater risks. However, on a brighter note, the relaxed credit policies will certainly help banks ease their liquidity pressure and disburse capital into the market.

Divesting resources into the productive sectors of the economy has been a major policy hurdle in the Nepali economy. Even though there has been an increase in agricultural loans, it has not translated into increased production, indicating that the agricultural loans might have been misused and are not going where they should be. Such misallocation of resources has been a fundamental cause of every economic problem in the country. The policy has also failed to incentivize and facilitate private sectors investing in hydropower, one of the country’s most productive sectors. Missing out on incorporating such sectors, is not going to help Nepal leverage its strengths for economic gain.

The policy also has been unable to address the country’s housing and land prices problem. In the past, as interest rates have decreased, people have used that capital to purchase land and houses. Since its supply is limited, it has driven the price up and made it impossible for an average person to own a piece of real estate. Policies aimed at bringing down real estate prices according to the income level of the average Nepali would help divert investment of limited financial resources into productive sectors by discouraging rent-seeking behavior and encouraging entrepreneurship and value-adding culture.

Conclusion

The announcement of the policy has uplifted the private sector’s confidence. With various provisions to ease access to loanable funds to the general public and flexible policies to relieve the pain of construction, small and medium-sized businesses, and private sectors, NRB expects robust economic growth in this fiscal year. While NRB’s effort to tame the inflation rate within its target has been successful recently, it will be interesting to see how it manages to control inflationary pressure while aiming for economic growth. As the country’s average consumer is suffering from ‘stagnant income and rapid price increase,’ it will be imperative for the central bank to facilitate macroeconomic growth while addressing the microeconomic consumption needs of the general public.