Thursday, July 26, 2012

NEPAL: What is in the Monetary Policy 2012/13 for you?

As with previous tradition of brining out monetary policy after the fiscal budget is announced, Nepal Rastra Bank (NRB), the central bank of Nepal, rolled out Monetary Policy 2012/13 yesterday. Monetary policy doesn’t draw much attention like fiscal budget because its reach is limited to the banking sector (whose reach in turn is limited to few sectors that can contribute very little to enhancing productive capacities), is constrained by fixed exchange rate between Nepali rupee and Indian rupee, and supply-side constraints whose remedy is beyond its reach.

Few highlights from monetary policy:

  • Targets for FY 2012/13:
    • GDP growth: 5.5 percent
    • Inflation: 7.5 percent
    • Money supply growth: 15 percent
    • Deposit growth: 15.1 percent (Rs 1160 billion)
    • Credit growth to private sector: 16 percent
    • Forex reserve: ability to finance 8 months of imports
  • Policy changes:
    • CRR increased to 6 percent for commercial banks, 5.5 percent to development banks, and 5 percent to finance companies. Earlier, it was 5 percent for all BFIs.
    • Bank rate increased by one percentage point to 8 percent
    • Deposit insurance of up to Rs 300,000 from Rs 200,000.
    • Deprived sector lending by BFIs increased by 0.5 percentage points. Commercial banks, development banks and finance companies need to lend 4 percent, 3.5 percent and 3 percent of their respective loan portfolio to the deprived sector.
    • Refinancing rates for agriculture and hydropower lowered to six percent from seven percent. BFIs to initially issue loans under the facility at rates of up to 9 percent.
    • Refinancing facility to migrant returnees on loans take for commercial purposes.
    • National Financial Literacy Policy and Financial Sector Development Strategy to be formulated. Financial Stability Unit to be set up at the central bank and it will bring out Financial Stability Report.
    • For overseas travellers, foreign currency facility for each travel increased to US$2500 for public and US$5000 for entrepreneur. Earlier, there was a cap of US$5000 for a year.
    • Commercial banks allowed to invest up to 30 percent of the amount parked in agency banks abroad in low risk instruments such as call deposit and certificate of deposit.
    • Interbank lending transaction set at maximum of 7 days.
    • PAN number mandatory while taking loan more than a set limit.

Few observations:

  • The main change that could affect the public the most is the increase in CRR (cash reserve ratio). It means that banks this fiscal year need extra money as idle cash/reserve, which will affect credit flows. The NRB argues that the objective of the hike in CRR is to mop up excess liquidity (estimated at Rs 100 billion). However, this policy might run counter to growth and lending targets. Importantly, there is a chance that BFIs might lower deposit rates and hike lending rates. This is not what the central bank wants though.
  • About growth and inflation targets, lets just say that it is beyond the NRB’s reach to meaningfully influence both these variables. First, growth rate next will get affected due to potential decline in agriculture production (thanks to late monsoon and shortage of fertilizers) and globally food prices might increase. It will affect both growth rate and inflation.
  • Lowering refinancing rate is a good move to channel credit to priority sectors. But the present provision to acquire such loans for six months only virtually makes it useless. It takes time to realize returns from investment and six months is too short a period for this purpose. It might be useful to traders, but will probably not make a dent on lending to priority sectors.
  • BFIs have been eagerly waiting for the so-called interest rate corridor, which sets a band for interest rates to fluctuate. Well, it seems it won’t come anytime soon as the NRB is still working on it.
  • There is a confusion over what exactly is the NRB trying to achieve? It has little traction on growth and inflation targets. It could ease lending to priority sectors and limit credit to unproductive sectors. It has already done so in real estate and housing sector. But, BFIs are not probably going to ease lending rates now even if they have excess liquidity. They will simply lower deposit rates and either maintain present lending rates or hike it on new loans. Interest spread is going to widen.
  • Looks like the central bank is in a fix. Whatever it does, there will always be unhappiness. If it wants to fuse bubbles arising from easy credit, then it is unpopular among investors. If it wants to redirect lending to productive sectors, then it is unpopular among BFIs. If it wants to have a grip on growth and inflation, then it is constrained by limited banking reach and its impact on real variables, and the pegged exchange rate.