Liquidity Crisis in Nepalese Banking System

With the start of the COVID crisis in December 2019, most of the economies were hit by supply as well as demand shocks and many of the economies experienced severe recession. In such a backdrop, central banks around the world come forward with aggressive monetary easing injecting a significant amount of liquidity in the system and cut in policy rates.  Nepal Rastra Bank also reduced its policy rates including CRR, bank rate and Repo rate to ease liquidity position in the banking system.

Decline in the demand for credit in the banking system and the monetary easing introduced by the NRB put the banking system in comfortable position during the first wave of the crisis. There was more than Rs. 100 billion excess liquidity in the banking system during August 2020 to December 2020 and the inter bank rate was close to zero. However, after that liquidity position has followed a downward trend. Currently, the liquidity position in the system has fallen below Rs. 30 billion.  

 

 Causes of the Stress

1. Mismatch between Resource Mobilization and Credit Demand

In the recent months, credit demand has surged while deposit mobilization has followed the trend.  In the three months of 2021/22, deposits have grown by Rs. 56 billion compared to the credit to private sector of Rs. 315 billion.  In the same three months of 2020/21, deposit had grown by Rs. 188 billion and credit to the private sector had grown by Rs.130 billion.

The average y-o-y growth rate of deposits in the three months of 2021/22 is 19 percent compared to the credit growth of 31 percent.

2. Decline in Remittances

Remittances are the major source of bank deposits in Nepal. Nepal receives around Rs70 billion remittances monthly. Such remittances have fallen by 7.6 percent during the three months of 2021/22 compared to an increase of 12.7 percent during the first three months of 2020/21.  In addition, pension and grants have fallen creating pressure on deposit mobilization.

3. Surging Imports

In the recent months, imports have surged in Nepal leading to a decline to a decline in reserves.  In the three months of 2021/22, imports have increased by 63.7 percent. It has resulted in a current account deficit of Rs. 151 billion compared to a surplus of Rs. 33 billion in the three months of 2020/21. Such trend has imports has led to a decline in the foreign reserve of the country by Rs. 80 billion during the three months.  

4. Sluggish Government Expenditure

Government expenditure has been sluggish following the similar trend of the previous years. As of December 10, 2021 (approx. first five months of 2021/22), total government expenditure is just 22 percent of the allocated amount while capital expenditure is only around 6 percent of the allocated amount. It has created a treasury surplus of the general government by Rs. 275 billion.

What has NRB Done?

NRB has taken a number of initiatives during the COVID crisis to resolve the liquidity crisis. Some of the measures include:

A reduction in CRR from 4 percent to 3 percent and reduction in bank rate from 6 percent to 5 percent.

New refinance schemes were introduced in 2021. NRB approved Rs. 148 billion refinance facility in 2020/21 and the outstanding amount at present is about Rs. 120 billion.

NRB approved around Rs. 1 billion to be disbursed under the Business Continuity Loan Program.

During the five months of 2021/22, NRB injected a total liquidity of Rs. 2600 billion through different open market operation instruments.

A provision has been made to provide one percentage point additional interest on the deposits made out of the amount received from remittances.

Restriction on the imports of silver and other commodities.

Way Forward

The liquidity strain in the banking system has continued for months and seems to continue some months in the future. Thus, NRB can introduce medium term instruments such as medium term targeted Repo to facilitate the liquidity positions of the banks. Extending the refinance facilities can be another option to support the resource mobilization of the banking system. Offering outright purchase auctions further could help the structural type of liquidity strain in the economy.

Besides that, managing the credit demand of the economy can help check the surging imports and maintain a balance between resource mobilization and credit demand. The government of Nepal as well NRB can coordinate to discourage the surging imports of gold and silver and other luxury goods. Moreover, remittances through formal channels should be encouraged and mobilized to productive activities.

Some other medium term measures may include encouraging the external commercial borrowing of the government and resource mobilization through NRN deposits and debentures.

The government of Nepal can help in easing the liquidity strain by expediting the government expenditure and using a prudent schedule for mobilizing internal debt.

With a combination of all such policy measures, credit demand by unproductive can be checked and a balance between resources and demand can be maintained while supporting the productive activities of the economy 

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The blogger can be reached at siddhabhatta@gmail.com

First Quarter Review of Monetary Policy 2022_23 Nepal

The Nepal Rastra Bank published its First Quarter Monetary Policy Review on 26 November 28, 2021. Here is an highlight from the policy document.

Monetary Policy Stance

Credit flow and imports have surged with the speeding of the economic recovery. Accordingly, the stance of monetary policy has been continued while being cautious for managing the surging credit demand, increasing the base of resource mobilization and ensuring resource availability for productive activities. In addition, monetary management will be made more effective taking into consideration the recent pressure on balance of payment and the likely pressure on inflation.

Monetary and Financial Measures

The existing cash reserve ratio, bank rate and statutory liquidity ratio have been kept unchanged.

Provision will be made for the banks and financial institutions to submit an action plan for maintaining the credit to deposit ratio within the specified limit by July 2023 after approving such plan from the board of directors.  

Considering the position of foreign reserve, cash margin will be made mandatory while opening letter of credit for importing specified goods.

The existing limit of Document Against Payment and Documents against Acceptance will be revised.

The maximum limit for importing silver will be tied up with the foreign exchange facility given for imports through draft and TT.

The existing provision for the interest rate and fees on borrowing in foreign currency will be revised.

The provision for mobilizing deposits in foreign currency from the non-resident Nepalese and the institutions involving the non-resident Nepalese will be further simplified.

The existing limit on foreign currency non-deliverable forward will be revised.

The policy documents can be accessed here.

The blogger can be reached at siddhabhatta@gmail.com  

 

 

Increasing Gap between Remittances and Imports in Nepal

Remittances are the life line of Nepali economy as they provide a cushion to foreign reserves and help finance imports. At household level, remittances have helped consumption and build-up of human capital. 

However, during the recent months, the gap between remittances and imports is widening creating pressure in foreign reserves. Foreign reserves of the country declined from Rs. 1470 billion in mid-October 2020 to  Rs. 1319 billion in mid-October 2021. Declining reserves and increasing imports has pushed the foreign reserve adequacy of the country from the imports of goods and services of 7.8 months from 14.1 months a year ago. (NRB, 2021).

Chart below shows the monthly imports and remittance inflows of Nepali economy during the last several months. Before the COVID-19, the gap between remittances and imports around minus 40 billion which narrowed down during the peak of the COVID crisis. However, as the restrictions were lifted and economic activities gain momentum, such gap has continuously increased and has crossed Rs. 60 billion during the last few months.

  Source : NRB (2021)

Declining reserves has  called the attention of the government, policy makers as well as economists in the recent months. There is a risk of a structural tending of falling reserves if imports continue to pick up in the medium term. As shown in the chart below, foreign adequacy reached as high as 15.6 months of imports of goods and services and is continuously declining thereafter. Likewise, foreign reserves reached the highest point of Rs. 1506 billion in mid-November 2021 and has followed a downward trend.

Source : NRB (2021)

It seems that the policymakers need to come forward with concrete measures  to manage imports and promote exports and tourism industry as a sustainable source of forex reserves in case remittances cannot support the imports. If the current trend persists and policymakers ignore the pressures created in currency account balance, balance of payments and foreign reserves, Nepal may face a structural problem in the external sector as faced in the 1980's.

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