Monetary Policy 2016/17: Highlights and Issues

Nepal Rastra Bank (NRB) unveiled the monetary policy for the fiscal year (FY) 2016-17 last month. It has been a formal practice in most of the countries that the central bank introduces Monetary Policy after the government announces fiscal policy, commonly known as the budget. As per the constitutional provision, this time around the Ministry of Finance came up with the budget at the end of May. 

Although NRB did not disclosed the monetary policy immediately after the fiscal policy was made public, it has tried to harmonise the goals and priorities adopted by the budget. As the central bank is considered to be the economic advisor of the government, NRB simply can’t contest the policy and priorities of the government. However, being an autonomous monetary authority and policy implementation partner of the government, NRB has the legal rights to correct target based on the findings of empirical studies and to suggest the priorities and strategies accordingly to maintain economic stability and fiscal discipline. 

Goals and Targets 
Despite opposition from the critics and sincere suggestions from the economists as well as experts, NRB dared not to revise the target set by the government, especially taming the inflation to 7.5 percent which now hovers above 10 percent. Due to the weak performance of the domestic industrial sectors, fragile supply system and political turmoil, it is almost impossible to achieve the target of consumer inflation. In the meantime, NRB has rubber stamped the government’s target of achieving 6.5 percent economic growth rate which was estimated to be less than one percent in the last FY. 

As per the monetary policy, the liquidity would be managed to maintain the growth of broad money supply at the rate of 17 percent, which, according to the bank, would curtail the consumer inflation to the targeted rate. Similarly, in order to achieve the economic growth of 6.5 percent, as stated in the budget statement, the policy has projected the internal lending to increase by 25 percent and the private sector credit by 20 percent. Meanwhile, the policy has also focused on directed lending provision, which states that 20 percent of banks’ total lending should be in agriculture and energy sectors.

Likewise, interest rate stability is another important area where the central bank should try to maintain stability in order to increase demand for credit from the industrial sectors. To this end, NRB has developed the theoretical mechanism for implementation of the concept of Interest Rate Corridor (IRC), which was introduced couple of years back with an aim to maintain predictability at the cost of borrowing of the industries. As per the provision of IRC, NRB set the lower and upper bands of the policy rates to maintain the short-term interest rates of the banking system within the range of these bands. It is assumed that such provision would increase the confidence of the industrial community which in turn would invite additional investments into the sectors. 

Major Features of Monetary Policy 
•    No changes in CRR and SLR
•    Appointing the Repo rate as a policy rate
•    Implementation mechanism of Interest Rate Corridor (IRC)
•    Mandatory Corporate Social Responsibility (CSR)
•    Focused on directed lending
•    Mandatory capacity development for bank promoters and employees
•    Strengthening capital base of BFIs
•    Relaxation on consortium financing and foreign exchange regulation
•    Introduction of Common Equity Tier-1 Capital Ratio (CET1-1)
•    Infrastructure Development Bank

Strengthening Capital Base 
The policy has increased the minimum paid-up capital for micro financial institutions (MFIs) that are supposed to provide wholesale credit to others. The policy encourages opening new MFIs in areas that do not have access to financial services. Similarly, it has been made mandatory that banks will have to spend one percent of their profit in the field of Corporate Social Responsibility (CSR). According to NRB, the idea is to increase financial literacy so as to promote the financial inclusion and deepening. However, it not justifiable to fix the percentage of profit those banks will have to spend in the field of CSR, since the provision is under discussion in the Industrial Enterprises Act (IEA) which is going to be promulgated soon. 

The Monetary Policy focuses on ramping up capital flow towards the productive sectors such as agriculture, energy, tourism, small and cottage industries. With an aim to provide financial access to marginalised communities and underprivileged people, NRB has made it mandatory to directly provide two percent of the total credit to the targeted group under the provision of deprived sector lending. In this context, the project loan up to one million rupees to be issued by the BFIs on the collateral of the Commercial Agriculture Project would be counted as 'Loan for the Deprived Sector.’ 

Although the provision for the commercial banks to issue 20 percent of their total loans in the designated productive sectors has been retained, the minimum limit of the loans to be issued to the agriculture and energy sectors has been increased to 15 percent from 12 percent. Likewise, the policy has the provision that the commercial banks which have to maintain four percent 'leverage' ratio on a quarterly basis from the next fiscal year need to reduce the proportion of the institutional deposit in the total deposits from 60 percent and keep it within the 50 percent limit.

Business Friendliness 
One of the welcoming steps of the policy is that the limit of mandatory consortium financing has been increased from 500 million to one billion rupees.The policy has also envisioned to establish Infrastructure Development Bank with the participation of the private sector for investing in the infrastructure developments. It has also incorporated the provision which requires the banks and financial institutions to set aside at least three percent of the total expenditure on employees on training and career development.

Similarly, the limit of convertible foreign currency for purchasing software which would be payable through India has been increased from the current maximum USD 10,000 USD to USD 15,000 for one time. Likewise, the limit of convertible currency payable through Draft and TT has been increased from USD 40,000 to USD 50,000.

Criticism 
Here it should be noted that the forced lending provision would create no more additional demand from the industrial sectors. It is the business environment that determines the economic activities and demand for credit from the banking system. Thus, the NRB should try to ensure policy stability through the innovative use of instruments of monetary (liquidity) management. This has also been tried by the NRB as the major policy indicators such as Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), Capital Adequacy Ratio (CAR) and Credit Deposit Ratio (CDR) that have remained unchanged. Nonetheless, the duration of achieving mandatory CRR has been increased to two weeks from one week.

What is IRC Framework? 
Interest rate corridor (IRC) is a system for guiding short-term market interest rates towards the central bank’s target/policy rate. It comprises a rate at which the central bank lends to banks (typically an overnight lending rate) and a rate at which it takes deposits from them (deposit rate).
In a standard corridor, the lending rate will be above the CB target/policy rate (thereby forming an upper bound for short-term market rates), and the deposit rate will be below the CB rate (thus forming the lower bound).
The IRC system is intended to help ensure that money market interest rates move within a reasonably close range around the CB’s policy rate. The close relationship between the policy rate and market interest rates provides the fundamental basis for monetary policy transmission. Through the IRC system, the CB will be able to generate a much effective policy signal as market rates closely track the policy target rate.

The Author is Director at Confederation of Nepalese Industries (CNI)