It was published in The Kathmandu Post, 21 July 2020.
Half-baked and misguided lending directives might further exacerbate asset-liability mismatches.
In his first annual monetary policy announcement as a governor of Nepal Rastra Bank, Maha Prasad Adhikari rolled out expansionary measures that aim to provide a healthy regulatory environment as well as immediate relief to businesses and households struggling due to the pandemic. The healthcare, economic and employment shocks have been unprecedentedly disruptive. Given the extended period of lockdowns, persistent supplies disruptions and subdued aggregate demand, economic growth in 2019-20 is projected to be much lower than the 2.3 percent estimated by the Central Bureau of Statistics before the virus took hold in Nepal. The shortage of goods and services has increased inflationary pressures, and lending interest rates have remained in the double-digits. The acute cash flow issues faced by businesses, and either layoffs or reduced working hours faced by individuals, have increased the risk of a liquidity crisis morphing into a solvency crisis.
Against this backdrop, the monetary policy for 2020-21 aims to achieve the ambitious 7 percent economic growth target set by the government, maintain adequate liquidity, limit inflation at 7 percent, encourage the merger of banks and financial institutions, enhance access to finance, and promote reliable digital transactions. The conventional monetary policy tools, as well as macroprudential policies, are much more accommodative than what we saw after the catastrophic earthquakes in 2015.
Accommodative measures
In addition to the targets mentioned above, Nepal Rastra Bank wants to ensure adequate foreign exchange reserves to cover seven months worth of imports of goods and services, adequate liquidity to facilitate economic recovery, 18 percent growth in money supply, and 20 percent credit growth to the private sector. To achieve these targets, it is planning to use a number of monetary instruments at its disposal.
Although controlling inflation is not fully within the central bank’s domain, thanks to the fixed exchange rate regime, it nevertheless has accommodated a higher inflation target than last fiscal year by rolling an expansionary monetary policy. For instance, it has reduced the policy repo rate, which is the rate of interest charged by Nepal Rastra Bank on the repurchase of government securities, by 50 basis points (bps) to 3 percent.
This essentially increases liquidity as banks can now borrow money at a lower rate from the central bank by selling the government securities they hold. Nepal Rastra Bank also uses the repo rate to maintain interest rates within the intended corridor, which is aimed at reducing interest rate volatility. Similarly, it has reduced the term deposit rate, which is the lower bound of the interest rate corridor, by 100 bps to 1 percent. This will discourage BFIs to deposit extra money at the central bank because the rate of return will be even lower. It has also committed to allowing long-term repo facility, if required, as current repo operations are limited to two weeks. In March 2020, it had already reduced the cash reserve ratio and bank rate by 100 bps to 3 percent and 5 percent respectively and lowered policy repo rate by 100 bps. These measures are aimed at increasing liquidity and lowering interest rates.
It has also provided regulatory relief by tweaking macroprudential policies, which are designed to mitigate system-wide risk and to reduce asset-liability mismatches. For instance, it suspended the 2 percent countercyclical buffer requirement, which commercial banks have been maintaining in addition to a minimum capital adequacy ratio of 10 percent. The additional buffer is imposed during normal times to lower systemic risk in case of a sudden deterioration of balance sheets. Further, the central bank has increased credit-to-core capital cum deposit (CCD) ratio to 85 percent from 80 percent till the next fiscal year.
NRB has also extended the moratorium on loan payments and allowed for restructuring as well as rescheduling of loans provided to Covid-19 affected sectors. Moreover, the central bank has also limited dividend payments and extended the deadline for issuing debentures or corporate bonds equivalent to at least 25 percent of paid-up capital. Soon it will introduce a loan classification provision whereby good loans affected by Covid-19 may not be required to be classified as bad loans. For some loans that are not repaid by the fiscal year 2020, loan loss provisions could be just 5 percent.
Always a question of implementation
The challenge now is to ensure the measures outlined in the monetary policy are fully implemented in a timely fashion so that it reaches the ultimate beneficiaries—the affected household and businesses—and that it stimulates economic activities.
The monetary policy has addressed the supply of credit by facilitating liquidity availability. However, this does not mean all of it will be taken up. The demand for loans is contingent on the overall investment climate and growth prospects. Not many businesses will take additional loans just to keep employees in the payroll and pay variable costs related to rent and operations when there are already substantial losses piled up. The uncertainty over the trajectory of recovery further complicates the matter.
Banks and financial institutions are generally risk-averse due to a lack of improvement in the investment climate and governance. They may not be willing to extend credit to new or existing borrowers without being confident about timely repayment. Consequently, the additional liquidity facilitated by Nepal Rastra Bank may end up in its own vault; banks may see it safer to park funds there even if the rate of return is much lower.
The central bank should be ready with a contingency plan regarding a possible rise in non-performing assets after the interest moratorium period is over. Subdued business activities, tepid cash flows and potential job losses might lead to unserviceable loans. Despite Nepal Rastra Bank’s commitment to reschedule and restructure troubled loans, the risk is still there. Note that concerns have been raised repeatedly by international financial institutions about the low level of non-performing assets in Nepal. This is largely due to the ever-greening and at times imprecise classification of risky assets. Higher levels of such assets in the banking sector pose systemic risk, substantially lower credit growth, and ultimately affect economic growth.
Furthermore, the large refinancing facility may not be fully utilised if banks do not see viable investment projects or creditworthy borrowers. For instance, the past refinancing pool offered to households for the reconstruction of residential houses destroyed by the 2015 earthquakes has not been utilised fully.
Finally, the aggressive push on directed lending—constituting about 40 percent of total loans, up from 25 percent last fiscal—could increase banking sector inefficiencies if proper due diligence is not followed through when extending credit to such sectors. Forcing banks and financial institutions to extend credit to particular sectors if they do not have expertise in evaluating the soundness of projects is not a good strategy. It invites political interference and fosters moral hazard behaviour. For instance, what happens if banks are forced to meet the mandatory share of lending to the energy sector if hydro projects fail to finalise a viable power purchase agreement? Similarly, what happens if farmers fail to pay their debts on time (in the past, the government waived them off with taxpayer-funded fiscal rescues). Half-baked and poorly governed lending might further exacerbate asset-liability mismatches.
