Load-shedding’s load on the Nepali economy

It was published in Nepali Times, ISSUE #620 (31 AUG 2012 - 06 SEPT 2012).

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Load on the economy

Besides the inconvenience, long hours of load-shedding will severely stunt the country's economic growth

Looking at the poor monsoon rains, rising demand and close to stagnant electricity production, Nepal Electricity Authority (NEA) projected that without immediate remedial measures load-shedding during winter could reach as high as 20 hours per day.

Prime Minister Baburam Bhattarai convened a meeting of stakeholders and asked them to limit load-shedding to 12 hours like last year. The Ministry of Energy (MoE) then floated a proposal whose immediate implementation would help the government reach its target. The plan includes construction of a 15 km transmission line to carry electricity from India during winter, operation of multi-fuel plants in Duhabi and Hetauda, construction of the Khimti-Dhalkebar transmission line, reduction of leakages, purchase of additional electricity from India, and expediting work in hydro projects.

However, as it stands now, the reality is that load-shedding will definitely go beyond 12 hours. There are no quick fixes to our power crisis unless production catches up with soaring demand. Meantime, as in previous years, hours of darkness will continue to erode the competitiveness of Nepali goods and services, weaken the industrial sector, widen trade deficit, and jeopardise fiscal balance.

Currently, electricity demand during peak time is around 1000MW, but supply is barely 700MW during summer and 400MW during winter, which includes total NEA production from hydro and thermal, purchase from the private sector, and import from India.

Of the total availability, NEA supplies 55 per cent (including both hydro and thermal), private sector contributes 27 per cent, and 18 per cent is imported from India.

As a result of increase in purchasing power boosted by remittances, trading services are booming. Furthermore, new consumers, which doubled between 2005 and 2011, seeking electricity from the grid are also increasing annually. While demand increases by around 100MW every year, electricity production is moving at a snail's pace.

First, due to the inadequate supply of electricity, firms will be forced to depend on petroleum products (especially diesel, which carries the most weight in NOC's losses and whose consumption more than doubled between 2007-08 and 2010-11) to power up their factories and offices. This will increase the cost of production and erode competitiveness of Nepali goods and services. Since cost of domestically produced goods might be higher than the cost of imported goods of similar nature, industrial activities may continue to further slowdown. Besides, power generated from diesel run generators can fulfil only 25 per cent of total electricity demanded by firms.

Nepal is already ranked as the least competitive economy in South Asia with high cost of doing business. According to Enterprise Survey (ES) 2009, lack of electricity is the second biggest obstacle to investment and is inflicting losses of 27 per cent of annual sales.

Second, exports, especially those of the manufacturing sector, will continue to be hit by mounting costs, leading to further slowdown of manufacturing output, which has already declined from 7.6 per cent of GDP in 2004-05 to 5.8 per cent of GDP in 2011-12. Meanwhile, new investments except for in services and hydropower sectors might decline as in the past. Worse, some of the existing firms will go out of business and most will operate below potential. All of these will hit economic activities and employment opportunities.

Third, the rise in demand for petroleum products will mean long queues at petrol pumps and rationing of LPG cooking gas. The NOC will see its balance sheet deteriorate as it is forced by the government to subsidise diesel, kerosene and LPG. The increasing import of petroleum products, which was about Rs 96 billion against total merchandise export of about Rs 65 billion last year, will further widen the trade deficit. Generally, consumption of petroleum products is inversely related to the supply of electricity.

Fourth, the government will have to fork out more money for petroleum subsidies (around Rs 10 billion last year), putting extra pressure on fiscal deficit, which stands at about four per cent of GDP. A portion of tax revenue collected from taxpaying citizens will unfairly be used to subsidise diesel consumed in large quantity by those who can afford it in the first place, making it the most off-target subsidy.

Based on the current pace of construction, demand will continue to outstrip supply at least until 2017. Excessive politicisation of the hydro sector and inefficiencies within NEA have been the two biggest hurdles so far. And unless construction of hydro projects and new investment are ratcheted up drastically, the outlook remains grim.

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Review of Nepali economy in fiscal year 2011-2012

The annual macroeconomic update published by the central bank is one of the few government documents I eagerly wait for each year. Finally, the macroeconomic update for 2011-2012 is out.  The state of some of the most important macroeconomic variables are briefly discussed below.

GDP

• GDP growth rate: NRB uses the same figures provided by the CBS, i.e. projection of 4.63 percent GDP. For more on these, see an earlier blog post here.

Merchandise trade

• Total exports was Rs 74.26 billion, total imports was Rs 461.67 billion and total trade deficit was Rs 387.74 billion, an increase by 15.4 percent, 16.5 percent and 16.7 percent respective when compared to the previous year.
• This was largely helped by depreciation of Nepali currency against the dollar. As a share of GDP, exports, imports and trade deficit were 4.77 percent, 29.63 percent, and 27.86 percent of GDP (share of import and trade deficit was higher than the previous year).
• Import of petroleum products was Rs 92 billion, a solid 23 percent increase from the previous year.

Balance of payments

• BoP surplus reached Rs 127.70 billion (US$1.57 billion) compared to Rs 2.18 billion (US$34.7 billion) in the previous year. The increase in BoP surplus in local currency was 5758 percent while that in dollar was 362 percent!
• Current account surplus was Rs 75.98 billion (US$ 909 million)compared to a deficit of Rs 12.94 billion (US$177 million) in the previous year. The improvement was due to substantial rise in growth of remittances and favorable services account.
• Remittances reached Rs 359.55 billion (US$4.41 billion). Net services balance was Rs 14.06 billion.
• FDI was Rs 9.20 billion (Rs 6.44 billion the previous year).

Forex reserves

• Forex reserves increased to Rs 439.46 billion (US$4.96 billion), up from Rs 272.15 billion (US$3.84 billion) the previous year.
• Reserves in convertible foreign exchange was US$3.87 billion. Reserves in inconvertible foreign exchange was IRs 60.39 billion.
• Annual average exchange rate in 2011-12 was US$1=NPR 81.02, up from NPR 72.27 in 2010/11.
• NRB purchased Indian currency equivalent to Rs 213.95 billion by selling US$2.66 billion in the Indian money market. It was US$2.74 billion (INR equivalent to Rs 198.15 billion) the previous year.

Tourism

• Inflow of tourists via air was 595262, with Indian tourists accounting for 28.32 percent of it. Indian tourists increased by 29 percent in y-o-y basis.
• Total tourists via air and land was around 750000.

FDI

• The DoI approved 227 joint venture projects with FDI commitment of Rs 7.14 billion. In 2010-2011, it was 209 projects with FDI commitment of Rs 10.05 billion.
• Largest number of JV approved were from China, followed by India, USA and South Korea.

Foreign employment

• The DoFE granted employment permits to 384665 Nepali migrant workers, an increase by 8.4 percent from last year.
• About 27.5 percent went to Qatar, 25.6 percent to Malaysia, 20.9 percent to Saudi Arab, 14.1 percent to UAE, 6.4 percent to Kuwait and 5.5 percent to other employment destination.

Inflation

• Inflation was 8.3 percent (provisional figure). It will be much higher when the actual figures are computed. The current market prices of goods and services do not justify the low figure. Even the central bank figures show that between Jun/Jul 2010-11 and Jun-Jul 2010-11, inflation was 11.5 percent.

Debt

• Domestic financing of budget deficit amounted to Rs 36.41 billion, which is about 2.3 percent of GDP.
• Total domestic debt was Rs 198.12 billion.

Revenue and expenditure

• Government expenditure increased by 11.9 percent to Rs 310.75 billion (up from Rs 277.62 billion the previous year). Recurrent expenditure was Rs 231.79 billion and capital expenditure was Rs 40.83 billion.
• Revenue was Rs 244.15 billion, up by 22.2 percent. VAT constituted 29.6 percent of total revenue, customs 17.8 percent, income tax 21.4 percent, excise 12.5 percent, and non-tax revenue was 15.4 percent.

Monetary situation

• Money supply (M2) increased by 22.7 percent against 12.3 percent increase in the previous year. Significant rise in foreign assets (net increase by 59.1 percent compared to 1 percent increase in the previous year) of monetary sector was the main reason behind this increase.
• Domestic credit increased by 8 percent, which is a slowdown from 14.6 percent increase in the previous year. Reasons: high revenue mobilization but low public expenditure plus low growth of claims on private sector (thanks to sectoral credit limit in unproductive sectors).
• Deposit mobilization increased by 22.9 percent (Rs 188.59 billion) compared to 12.9 percent (Rs 94.13 billion) the previous year. Reasons: high remittances and modest increase in export earnings.
• Loans and advances of BFIs increased by 13.2 percent (Rs 112.78 billion) compared to 15.1 percent (Rs 111.91 billion) the previous year. Reason: merger of some finance companies with commercial and development banks.
• As of mid-July 2012, there are 32 commercial banks, 88 development banks, 70 finance companies, 24 microfinance development banks, 16 NRB licensed cooperatives, 36 NRB licensed NGOs, and 25 insurance companies. In just a year, the number of finance companies decreased from 79 to 70.

Share of Kathmandu valley in national economy

Ever wondered the share of Kathmandu valley (Kathmandu, Lalitpur and Bhaktapur) in the national economy? Well, it contributed between 23.4 percent and 31 percent (based on “reference scenario” and “alternative scenario” respectively) to national economy [that is, C+I+G+(X-M)] in 2010/11, according to this study by the central bank.

Since the total population of Kathmandu valley is 2.51 million (Census 2011 preliminary data or 4 million as assumed in the study considering temporary population as well), it means that a region with 9.44 percent (or 15 percent if temporary population is considered) of total population and less than one percent of total area contributes almost one-third of the total economic activities (considering alternative scenario). Reference scenario is based on published data sources (mainly NLSS III—and other surveys like CME 2006/07 and SSME 2008/09—for private consumption expenditure and investment, MoF data for government expenditure and investment, and customs data as well as field survey for trade) and field survey. Alternative scenario is based on reference scenario plus underestimated data (consumption of electricity and petroleum products) obtained from field survey.

The figure below shows the share of Kathmandu valley in respective components of GDP. The share of Kathmandu valley in total national consumption and exports is around one-fourth each.

Source: NRB, 2012; *alternate scenario.

Furthermore, considering alternative scenario, the share of Kathmandu valley in consumption of food, electricity and petroleum products is 19.8 percent, 29.2 percent and 30.7 percent respectively. Meanwhile, the share in consumption of LPG, petrol, diesel and kerosene is 60 percent, 46 percent, 16 percent and 38 percent respectively. With the huge share of consumption in the richest region that also has bureaucratic centers and most jobs, it is no surprise that there is some form of elite capture of subsidies meant for the poor in particular and for all in general. Sounds like an extremely off-target subsidy of all.

Regarding financial sector, while 60 percent of deposits originated in Kathmandu valley, the share in total credit was 44 percent. About 26 percent of total BFI branches are in Kathmandu valley.

The effectiveness of policy briefs

Below is an excerpt from a very interesting paper on the effectiveness of policy briefs (which are basically an evidence-based specific topic focused writing that can be read and understood by people having some interest in the issues explored)  done by Beynon et al. at ODI. Read the full paper here.

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[…]Most of the factors that influence research uptake are beyond the control of research communicators. But one factor that is within their control is the design and dissemination of the documents they produce for policy audiences. In particular, the design of their policy briefs.

[…]Using a randomised control design, this study explored the effectiveness of one popular research communication tool, a policy brief, and queried whether different versions of a brief bring about different results. We find that the policy brief had little effect on changing the beliefs of readers who held strong prior beliefs on entering the study, but had some potential to create evidence-accurate beliefs among readers holding no prior beliefs. Also, when it comes to beliefs, the impact of the policy brief seems to be independent of the specific form of the policy brief. However, different versions of the brief (versions that include a research Opinion with or without a suggestion that the opinion is from an Authoritative source) do achieve different results when it comes to prompting actions. We find that other factors internal and external to the brief (gender of the reader, reader’s self-perceived level of influence and the extent to which the reader feels ‘convinced’ by the brief) are also linked to action.

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It should be pretty useful for NGOs and think-tanks that are wondering how to make their research effective at policy level (evidence-informed policymaking) as well as to influence public discourse on a particular issue.

NEPAL: Making sense of government data and where to find them

Here are few points that will help simplify your life if you are playing with and trying to make sense of the data provided by various government agencies in Nepal. Most of the data can be found in Economic Survey (ES) and Quarterly Economic Bulletin (QEB). These are helpful if you are trying to look at figures based on fiscal year. Alternatively, you can also use databases of ADB, WB and IMF.

GDP growth rate: It is better to compute real GDP growth rate yourself because if you use the government provided one, then you will notice that for 2000/01 the data is missing. It is because real GDP is computed with 2000/01 as base year. Compute real GDP growth rate using real GDP at factor cost/basic prices (at 2000/01 prices) for sectoral contribution. Compute GDP in producers prices (at 2000/01 prices) for growth rate usually used for normal purposes (the base year before 2000/01 differs).

GDP per capita: In some economic surveys you might find that GDP per capita growth for some years is higher than real GDP per capita (for instance, according to Economic Survey 2011/12 p.xxii, in 2006/07 real GDP growth was 2.8 percent but real per capita GDP growth was 6.3 percent!). It should not happen. To stay in safe side, compute your own figures. Use real GDP at factor cost (2000/01 prices) for the years you are looking at and divide it by total population in that year. The CBS provides an estimation of population in each fiscal year.

Trade: Use export and import figures from QEB. The ES keeps on messing up with data for 1985/86. You can get disaggregated export and import data based on SITC category. Better compute trade deficit on your own. Export and import data are available for Nepal’s trade with India and outside of India because almost 60 of Nepal’s trade happens with India. For disaggregated export and import figures, use TEPC’s database. If you want to access trade data disaggregated at various levels, then either use UN COMTRADE or ITC’s database (you will have to use mirror data for most of the years as reported figures are for 2003, 2009 and onwards only).

Exchange rate: Nepal has pegged its currency with Indian rupee. So, it hardly changes unless the government alters the peg, which hasn’t happened since 1993. For others, use annual average of buying and selling rates available in QEB. On February 12, 1993, the Nepalese rupee was made fully convertible on current account. Between June 1, 1983 and February 12, 1993, Nepali rupee was pegged with a basket of currencies. Prior to 1983, Nepali rupee was pegged and revalued or devalued depending on the situation.

Inflation: Use QEB. Compute inflation yourself from CPI data whose base year is 2005/06. Rural and urban inflation data are also available.

Gross domestic savings and gross national savings: Use ES. GDS is calculated as the difference between GDP and total consumption expenditure in the national accounts statistics., i.e. GDP at producer's prices (current) minus consumption. GNS is calculated as gross national income less total consumption, plus net transfers. Saving-investment gap = GNS-GCF.

Expenditure: Use ES. After 1998/99, total expenditure is divided into recurrent, capital and principal re-payment. Before that it was only regular and development expenditures. If you are looking for expenditure based on just regular and development headings, then regular expenditure = recurrent and capital=development.

Receipts: Use ES. It includes tax revenue, non tax revenue and foreign grants. Customs revenue contains imports, exports, Indian excise refund and others. VAT includes sales tax, entertainment tax, hotel tax, air flight tax and contract tax. Compute tax revenue as a share of GDP on your own (do not use total receipts as foreign grants and non tax revenue might distort the overall message!).

Foreign aid: Use ES. It has aid data disaggregated by type, sectoral flows and source. For country-wise aid commitment, see source books/white books. For a review of aid flows see Foreign Aid Co-ordination Division’s publications (particularly development cooperation reports). The OECD’s aid database also gives good data on ODA and Aid for Trade flows.

Migration: Use figures from the Department of Foreign Employment (DoFE), which gives you data since 1994/95. Gender disaggregated data is available starting 2006/07. The DoFE data covers only those who are given employment permits to work in foreign countries. It doesn’t include those going to India for work or going to other countries without seeking employment permits. A rough approximation of those going to India and other countries is available from ‘absentee population’ data in decennial censuses (from 1941 to 2011).

Remittances: Use remittances figures extracted from balance of payments table in QEB. This gives remittances recorded in foreign exchange only. Remittance income might include remittances in all currencies (i.e. Indian currency and others). Since Nepal has a pegged exchange rate with India and the Indian rupee is also used in the market for transaction purpose, recorded remittances in foreign exchange might understate the actual inflows. The household living standard surveys (NLSS I, II, and III) gives an approximation of remittances coming from different sources, including India. The WB’s remittances figures are also widely used.

Forex earning: Use QEB. Foreign exchange earnings come from remittances, tourism, investment income, exports, diplomatic source, foreign aid and miscellaneous.

FDI: Use FDI data from BoP table from QEB. For FDI commitment from different countries disaggregated by sector and employment, use Department of Industry’s industrial statistics year book.

Poverty and inequality: Either use NLSS (for national poverty line) or World Bank figures (for US$1.25 a day poverty line). Some use Multidimensional Poverty Index primarily used by UNDP in its annual HDR.

Social progress: For a comprehensive look at progress made since 1990, see MDG assessment reports. For other indicators, see NLSS I, II and III.

[Lastly, GDP at basic prices or factor cost = GDP at producers' prices or market prices - taxes + subsidies. GDP at factor cost is used for computing sectoral contribution to GDP; GDP at producer's prices/market prices (current) is used for calculating share of other variables.]

More load-shedding during the dry season

As a result of low monsoon rains and increasing demand (estimated to increase by around 100 MW each year), a large portion of Nepali households could see load-shedding hours going up to as high as 21 hours a day. It will have a severe impact on production and export competitiveness, trade deficit, investment, capacity utilization of existing firms, fiscal balance (more demand for diesel as it is subsidized) and inflation. Currently, electricity demand is around 1000 MW but supply is 700 MW during summer and 400 MW during winter. The number of new consumers is also increasing rapidly.

The government is trying to contain the damage and plans to limit power cuts to 12 hours a day. Here is the proposed plan as reported in Republica:

• Construction of a 15-km transmission line to carry electricity from India during winter
• Operating multi-fuel plants in Duhabi and Heatuda
• Construct Khimti-Dhalkebar transmission line to reduce electricity leakage by about 10 MW
• Control leakages
• Buy more electricity from India during winter
• Expedite work on hydro projects

These plans have come out of desperation. But, desperation alone won’t provide relief if the country cannot generate enough electricity in the first place. The reasons for this are simple: too much politicization of hydro sector and entrenched corruption and inefficiency. Willing investors from India are pretty much opposed by politicians from the most influential party (but are more than willing to import electricity from India though). Investors from other countries are simply waiting to secure the most lucrative deals. Meanwhile, the light bulbs of Nepali households are getting fewer hours of electron flows each year. It is unfortunate that the sector in which we have comparative advantage in production, and also in export, is being politicized to the extent that supply is at snail’s pace while demand surging far ahead.

Few comments:

• Do whatever, the cost of production will increase next year and investment in non-resource sectors (i.e., primarily manufacturing, which produces the most gainful employment and bump in income with low volatility) will go down. Fiscal balance will get impacted as more hours of power cuts means more demand for alternative sources of energy (in our case, diesel). This will be compounded if the diesel plants are run and NEA will have to bear further losses. Imports bill will shoot up and trade deficit will further widen. A slight decrease in remittances growth will destabilize whatever macroeconomic stability we have right now.
• Given the acute shortage of electricity in India itself, I wonder if they will be willing to increase exports to Nepal each year. In fact, other South Asian countries like Bangladesh and Pakistan also have deficit power production. With so much power potential and willingness of donors to construct cross-border transmission lines, Nepal has a huge opportunity to cater to this market. Sadly, it is not happening. Rather, our leaders are more willing to import electricity from India but oppose investment from Indian investors. It is simply illogical.
• Controlling leakages is not as easy as it is said. It requires more funding for the supervision, regular maintenance of dilapidated transmission lines, and periodic repair of existing power plants that are operating below potential.
• The state of Nepal’s infrastructure is already miserable, ranking Nepal as one of the most uncompetitive nations in South Asia. Business costs are already high. State of ICT is also pathetic. The only solution to these is to produce more electricity so that cost of production are down and investor’s confidence is boosted.

Will introduction of base rate help the troubled financial sector in Nepal?

Here is an article by Prem Khanal published in Republica yesterday. The entire article is copied and pasted below.

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Second coming

PREM KHANAL

Nepal’s financial system seems to have come full circle as it is headed towards the same bumpy path that ended with a banking crisis in 2010. A flashback: Between fiscal 2004/05 and 2008/09, Nepali economy witnessed a breakneck monetary expansion and the total money supply, during the period, increased by 17 percent on average, owing to hefty growth in remittance. As a result, bank deposits doubled to Rs 422 billion in four years and liquidity soared due to low credit demand, despite record low lending rates. The one-year deposit rate remained at 4 percent for almost five years whereas inflation was 7 percent on average.

The negative interest rate that shrunk depositors’ savings by at least 3 percent each year for five years became a great disincentive to park saving at banks. This along with low lending rate diverted depositors toward highly risky speculative investments. Four distinctly visible scenarios emerged during the period. First, those with moderate deposits, say more than Rs 1 million, managed additional financing from banks and invested in real-estate, mainly on land. The sudden rise in the demand of land increased its price and provided handsome returns for both individuals and lending banks. That not only prompted initial investors to invest even more by taking additional loans but also lured others looking for alternative investment avenues to avoid negative interest rate and secure high returns.

Banks were happy as they were easily securing monthly installments and confidence of real estate traders was at a high as they enjoyed hefty returns. Real-estate lending soared to Rs 25 billion in 2009 from Rs 1.4 billion in July 2006. However, the realty business started losing steam in the beginning of 2009 and real-estate bubble burst in early 2010, putting at risk Rs 100 billion worth of bank investments. Two years down the line, the banks are trying hard to recuperate.

Second, those without enough savings to invest in real-estate were initially lured by the share market, which witnessed a whopping expansion, as market capitalization as percent of GDP jumped to 52 percent in 2008/09 from 11 percent in 2004/05 and the number of listed shares increased by three-fold. The share market soon started showing irrational behaviors. Even the shares of the companies that had declared their inability to generate profit for at least five years saw their shares oversubscribed manifold. Similarly share prices of some new finance companies increased by up to four-fold, even before they had released their first audited financial reports. That phenomenal growth in turn made banks invest heavily in margin lending—lending against share certificates—which rose to almost Rs 9 billion in July 2009 from nowhere.

The manipulation in the share market spurred mainly by weak regulations was so alarming that the share prices of regional financial institutions, with capital of Rs 100 million, were for years being traded at much higher prices than that of national banks, whose capital were Rs 2,000 million. But share market soon started losing its shine following the slump in realty business, as ballooning realty sector was the main propeller of the stock market. The contraction of the share market was so rapid that market capitalization was squeezed to Rs 377 billion within a year from its peak of Rs 513 billion in July 2009.

Third, those residing in border areas of the southern planes where there was neither realty boom nor shining stock market for speculative investments, shifted deposits, worth billions of rupees, to Indian banks offering as high as 12 percent interest in one-year deposits. The bordering Nepali markets were so lucrative for the Indian financial institutions that they used to put advertisements on Nepali side, promising quarterly interest payments at doorsteps. The fact that Nepali banks operating in bordering cities witnessed an unexpected increment in collection of Indian currency after Nepali banks increased deposit interest rates in 2010 was a strong evidence that low interest rate was one of the major reasons for the huge capital flight to India during the period. In addition, low interest rate also created conducive environment for various networking and insurance schemes to penetrate into the bordering Nepali markets.

Fourth, those in the emerging towns making small savings either from the money they were receiving from family members abroad or from local business, but had no access to share market, were attracted by illegal pyramid-styled networking business that promised unnatural returns. The infamous Unity Life scandal in which innocent people from rural and emerging cities lost Rs 3 billion was a brilliant example of the level of risk savers are ready to take even for moderate returns.

Against these facts, the recent rapid decline in deposit interest rate that was as high as five percentage points is a clear early warning that Nepal’s financial system is warming up for return to the vicious circle that shook the very foundation of the banking system in 2010. As remittance income continues to rise against the background of slow credit demand, and with liquidity in banks building up to around Rs 40 billion, it leaves banks no alternative to lower deposit rates. They are sure to further bring down the lending rate that so far has declined by three percentage point on average. The deadly combination of low deposit and low lending rates once again can goad people towards risky speculative investments. Though chances of reemergence of a real-estate bubble in near future is slim given various restrictions enforced by the central bank, particularly on land, the economy will surely see bubbles on other sectors if the current vicious circle of low-deposit-lending is not broken.

But how? Global experience shows that implementation of a functional base rate or benchmark rate for lending is an effective tool to deal with the abovementioned problems, though it is also not without shortcomings. The practice of adopting base or reference rate has become a popular tool to reduce lending risks, particularly after the global financial crisis and many regional central banks like Reserve Bank of India, have successfully implemented the policy to avoid lending risks. Indian experience show that the base rate policy has been effective in controlling lowering of lending rate to some borrowers that come with right political or commercial connections but lack adequate financial backings and real entrepreneurship skills.

To its credit, Nepal Rastra Bank in its monetary policy for current fiscal year as vowed to introduce a base rate, a monetary mechanism that will fix the minimum lending rate below which banks will be not allowed to lend. Since banks themselves have to fix the lending base rate on the basis of major cost elements like cost of deposits, cost of maintaining the SLR and CRR, cost of operations, and profit margin on each quarter, it will improve transparency in the banking sector’s interest rate mechanism.

The introduction of base rate will not only open a new avenue for floating interest rate to borrowers, who currently have no option than to accept fixed rate, but also help the central bank to maintain a solid base to determine spread rate. Moreover, it will help peg the deposit rate at a certain level above the inflation rate so as to ensure minimum reward for depositors.

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Comments: The article focuses on the rising spread rate and the various ways in which money is being used (real estate, share market, deposit in Indian BFIs, and pyramid schemes). He bats for introduction of base rate as one of the most viable solutions. But, then it is just a policy tool to stabilize lending and deposit rates within a certain band. It would have been even more revealing if the four main ways in which people are using money and the policy recommendation were linked with the core problems of the banking sector: intense (and unhealthy and non-innovative) competition among too many BFIs and lack of appropriate investment opportunities, which has in turn resulted in bubbles in certain sectors.

In January 2011, I had cautioned about the impending financial disaster and then in January 2012 I argued that the crisis is postponed (possibly) until mid 2013. The core problem is still there and few policy tweaks on the surface would only make a minor scar. Here is a long version of an analysis on the same issue. Also read this one.