Monitory Policy 2018/19: An Active Accommodation to the Fiscal Policy

Monetary Policy is an institutional mechanism, which regulates the supply of money, or liquidity in the economy with an aim to achieve some desired policy goals. The policy goals to be targeted by the country's central bank or monetary authority depend on various factors ranging from the state of development, independence of the central bank, degree of monetization of the economy, political economy of the country and the external linkage of the economy. The common goals of the monetary policy are related to the maximum level of output, higher level of employment, stable price level, external balance and interest rate stability.

However, the central banks of the respective country have been granted to choose among the policy goals depending on the need of the economy, suitable environment for implementation and available policy instruments as well as indicators. In this regard, Nepal Rastra Bank (NRB) as the central Bank of Nepal has a greater operational independence in the conduct of monetary policy provided by the NRB Act 2002. The Act has mandated the NRB play an important role on economic development of Nepal by promoting economic growth and ensuring price stability.

In this article attempts have been made to analyse the monetary policy 2018/19 recently unveiled by NRB. Simply the provision introduced first time this year and the major revisions from the previous policies have been highlighted so as to make them understandable by every spare of stakeholders. In the meantime, changes and impacts expected to be brought into the economy from the policy have also tried to be envisioned.  

1.    Policy Direction

NRB has clearly indicated that the monetary policy for FY 2018/19 would expansionary enough and aims to accommodate the fiscal policy announced by the federal government one and half month ago. The central bank has been hopeful that the monetary policy would help achieve the economic growth target of 8 percent in the fiscal year while containing the inflation rate at 6.5 percent.  These goals are broadly in line with the mandate given by the NRB Act while devising the monetary policy.

Considering the government's aspiration for high economic growth and resulting demand for loanable fund in the banking system NRB has reduced the Cash Reserve Ratio (CRR)---the minimum deposit that the banks have to maintain with NRB in cash---by maximum 200 basis points. Similarly, the Statutory Liquidity Ratio (SLR) has also been reduced by the same rate for all categories of financial institutions. Such a huge reduction in CRR and SLR would increase the monetary base of the central and increase the lending capacity of the banking system by almost 50 billion Rupees.

According to the current values of Deposit Expansion multiplier and Money multiplier, the additional money released from the central bank's coffer to the banking system would enables the banks and financial institutions to create fresh credit of around 200 billion Rupees. This fresh credit/loan, if goes to the productive activities, would generate the economic activities of around 500 billion Rupees within the country. Thus, if implemented effectively this policy would accommodate the fiscal policy realizing the targets economic growth and inflation.

Policy Targets:

·         Economic growth to be achieved 8 percent

·         Inflation to be contained at 6.5 percent

·         The growth of broad money (M2) to be maintained at 18 percent

·         Private sector credit projected to grow 20 percent 

2.    Investment Promotion

It is well observed that the demand for long-term loan has ever been increasing along with the new projects like big hydropower, manufacturing and tourism industries have been coming up. In the meantime, the country's banking system has been facing acute shortage of fund to be mobilized to those long-term projects, which is resulted into a surge of interest rate very frequently. The rising and unstable interest rates have been discouraging the investors leaving them in a dilemma of whether the envisioned projects would be commercially viable or not.

In such a situation, NRB has introduced few policy measures which help to expand the base of loanable fund with the banking system. First of all, NRB has opened the door for BFIs to take loans of up to 25 percent of their primary capital in Indian currency too. Earlier, the provision was applicable only to convertible foreign currencies other than Indian currency. The central bank has now maintained a similar provision for microfinance institutions. Similarly, the policy has allowed the commercial banks to raise money from domestic market issuing debt instruments (debentures/bond) and permitted it to be counted as deposit while calculating the Credit to Capital Deposit (CCD) ratio. The CCD, which is currently 80 percent, has long been debated as a policy tools since the bankers were demanding to remove or increase it while the central bank was not ready to do that. Now at least the issue has partially been addressed though yet to see how effective it would be in Nepali market. 

Apart from introducing new policy measures, the central bank has continued with the existing ones which were in practice since long. However, some of the provisions have been revised so as to facilitate the additional credit liquidity in the system and in turn expanding the credit to the productive sectors. Firstly, by maintaining the minimum threshold of loans to be extended to the priority sector at 25 percent, NRB has asked commercial banks to provide at least 10 percent of the loans to the agricultural sector and 15 percent to energy and tourism. The limits for development banks and finance companies in the priority sector have been kept unchanged at 15 percent and 10 percent respectively.  Although the limit given to energy and tourism sectors is not enough to meet the growing demand of the sectors the concerned private sectors has welcomed this step of monetary policy.

Another welcome step of this monetary policy is that it has increased the size of refinance fund by 75 percent from 20 billion to 35 billion Rupees. Although this expansionary move of monetary policy is expected to address growing demand for loan from the manufacturing and export-oriented industries, the industrial sector (the target group of this fund) is not happy since they were asking the NRB to increase the time limit of refinance, which is just 2 years now.

3.    Interest Rate Stability

The monetary policy for the FY 2018/19 has attempted to address the issues of steadily rising interest rates in recent months. The skyrocketing and unstable interest rates had been headache for the bankers as well as industrialists, which has partially been addressed by narrowing down the interest rate corridor and reducing the bank rate at which the BFIs take loan from the central bank as a means last resort. The squeezed interest rate corridor would maintain the short run interest rates within a limited range restricting them to be more volatile and uncertain. As the short run interest rates signal the long run deposit and lending rates it is believed that the long run rates also would not go beyond a certain range. This would help maintain interest rate stability to some extent allowing the businesses to predict their costs of capital at least for the near future.  

The policy has urged to reduce the average difference between the deposit rate and lending rate to 4.5 percent from 5 percent although there is a question mark whether it be implemented effectively as such spread often used to be higher than the ceiling fixed by the central bank.  However, at least theoretically it implies that a bank would not be allowed to charge interest on credit higher than 4.5 percent of their average deposit rate. On the one hand the central bank is enabling BFIs by releasing additional money to the system and on the other urging them to bring down the interest rate spread than before. Thus, it is expected that the upward pressure on lending rates would stops and reducing the risk of ultra-high and unpredictability of interest rates in the economy.

Major Changes in Policy Instruments:

·         Ceiling and floor for interest rate corridor narrowed respectively from 7 to 6.5 and 3 to 3.5 percent  

·         CRR reduced to 4 percent for all BFIs

·         SLR reduced by 2 percentage points for commercial banks, 1 percentage point for development banks and finance companies

·         Bank rate (lending as last resort) reduced to 6.5 percent from 7 percent

·         Refinance fund size increased to Rs 35 billion from Rs 20 billion

4.    Financial Sector Stability

In addition of an attempt to stabilise the interest rate, the policy has also aimed to maintain financial discipline in the system and expand people’s access to financial services. As per the new provision, commercial banks do not have to take permission from NRB to open branches in locations outside metropolitan and sub-metropolitan cities. The central bank has raised the deposit guarantee limit to Rupees 300,000 from the existing 200,000.

In the meantime, NRB has also reduced the limit of overdraft on individual loans from Rupees 7.5 million to 5 million. The reduced overdraft limit to individual loan is expected to increase loans in the productive sector, which may help create more economic activities and employment as well as income of the people at mass. With an aim of building the confidence of foreign investors those who are willing to put their money in Nepal NRB has introduced an idea of hedge fund for the first time in Nepal. In this regard, NRB itself has taken responsibility of operating the hedge fund and managing the foreign exchange risk associated with foreign capital.     

Major New Provisions:

·       Bank can form subsidiary to get license of stock brokerage firm

·       Hedging facility on exchange rate risk to foreign capital coming in the country

·       Borrowing facility to BFIS in Indian currency up 25 percent of core capital

·       Full audit of the big branches of the commercial banks mandatory

·       Mandatory credit rating for the credit of Rs 500 million and above

·       Margin call on share loan only after 20 percent fall of the collateral value

·       Accounting the money raised through bond for CCD ratio

·       Cap on institutional deposit for all BFIs

·       Ban on stitching Nepali bank notes

·       Cap of 6 percent point on interest spread for MFIs

*The author is doing his Ph.D. in Economics from Tribhuvan University