The global economic situation continues to recover slowly and unevenly from the shocks of the COVID-19 pandemic and subsequent geopolitical tensions. Despite the faster recovery to growth, some central banks are still maintaining their tight monetary policy stance to manage the higher inflation. In this dynamic world today, the global economic context and geopolitical development spill over rapidly. The interconnectedness of global markets means that shocks do converge and policy harmonization is needed to tackle it.
We understand that a strengthened domestic financial system and robust institutional and policy framework is a necessary condition to withstand external shocks, whether they stem from global financial crises, trade disruptions, or geopolitical tensions. By observing the international best practices, we, therefore, require a proactive and tailored policy measures that suits to domestic financial and economic structure.
Domestic Monetary and Financial Developments
Nepal’s financial sector has undergone significant reforms, particularly during the three distinct phases. The first phase of reform, initiated in the mid-1980s, focused on liberalizing the banking sector, increasing the number of financial institutions, and enhancing the range of financial services offered. This phase led to a rapid expansion of banks and financial institutions, fostering greater competition and accessibility. Phase II, starting in the early 2000s, concentrated on improving regulatory frameworks, strengthening financial stability, and enhancing the operational efficiency of financial institutions.
However, post-2010, the focus shifted towards financial consolidation, driven by concerns over the proliferation of financial institutions and the need to address risks associated with rapid expansion. This period saw efforts to merge and consolidate financial institutions to create stronger, more resilient entities, capable of withstanding economic shocks and contributing to sustainable economic growth. These financial liberalization policies have catalyzed rapid expansion and development in Nepal’s banking sector, enhancing financial access and literacy. The deposit-to-GDP ratio has surpassed 100 percent, and the credit-to-GDP ratio is nearing 90 percent, the highest in South Asia.
Despite series of global and domestic shocks like the global financial crisis of 2008, and domestic shocks like the 2015 earthquake, state restructuring and the COVID-19 pandemic, Nepal’s financial system has shown remarkable resilience. We have implemented prudent measures and promoted financial consolidation through mergers and acquisitions to maintain a resilient banking sector.
Our focus is on better coordination between monetary and macroprudential policies. We have been putting efforts by directing credit towards priority sectors to ensure that the banking sector supports sustainable economic development and can reduce the risk of asset bubbles. We have also been promoting financial inclusion as a topmost priority, enhancing access, literacy and consumer protection measures about financial services.
The external sector stability is also associated with the remittance inflow and credit growth. We have seen episodes of balance of payments deficit when credit growth is higher when credit is financed for imported goods and services. Therefore, unless we have a sustainable source of foreign currency reserve, we do have limitations in external stability and thus we need to be cautious in managing our foreign currency reserve.
Recent Macroeconomic Scenario
Now let me share how NRB has been navigating the shocks that emerged from the global economy by highlighting the current macroeconomic situation. Nepal’s slower growth performance further deteriorated due to the COVID-19 followed by the tight policy stance as part of the global spillover effect, slipping from the historical average of 4.5 per cent to 1.9 per cent in 2022/23. The growth has now been recovered to 3.9 percent in 2023/24. Specifically, the construction, manufacturing, and trade sectors were contracted in these two fiscal years. The growth momentum of more than 7 per cent observed after the 2015 earthquake was halted by the COVID-19 pandemic and the global supply shocks.
Nepal also witnessed rising consumer inflation and currency depreciation. As a result, our consumer price inflation peaked at 8.6 per cent in September 2022. Because of the timely policy response, weak internal demand and some improvement in the supply side, inflation has now come down to 3.6 per cent in July 2024, with annual average inflation of 5.4 percent in 2023/24, well below the target of 6.5 per cent.
Nepal faced a rapid decline in foreign currency reserves from late 2021 till 2022, due to the decreased tourist income and remittance inflows to finance the up-surging imports. Nepal had to pursue a tightening monetary policy stance and restrictions on the import of some luxury goods to preserve the reserve depletion. We continued the higher interest rate policy regime for more than a year until May 2023, after which we followed the lowering path, considering the slackness in economic activities along with the improvement in the external sector and the consumer price inflation.
To address the debt distress and protect small and medium-scale enterprises as a result of higher interest rates, we introduced some regulatory forbearance and relaxation, loan rescheduling and re-classification, among others. At the same, we also introduced the working capital guideline for standardising the credit need assessments of corporate sectors. These measures were very supportive to the good borrowers while being able to address the moral hazard problem. The external sector is now robust, with a huge balance of payment and current surplus, FOREX reserve with import capacity of 13.7 months in July 2024. The interest rate has been declining, with weighted average lending rate of commercial banks being to a single digit in this July.
With the balancing measures, we have been successful in safeguarding the overall macroeconomic stability in Nepal. Now, the challenge is sluggish credit demand despite the lowered interest rate and over-liquid banks. Moreover, the decline in credit expansion despite lower interest rates highlights an effort to stimulate domestic demand with few significant improvements in the real sector.
Nepal Rastra Bank has been taking bold steps to the policy reforms as well. The latest steps include modernizing the monetary policy operations, enhancing credit quality, emphasizing digital banking and FinTech, developing a modern payment system and its integration into the global market, and continuation of the financial consolidation measures.
Challenges and Way forward of our Financial System
Nepal faces unique economic challenges, ongoing and emerging, both globally and locally. We are currently facing a significant challenge in our economic landscape characterized by low growth, low savings, and low investment. These conditions place an extra burden to the financial sector, especially the money market. In this context, while the role of monetary policy becomes more substantial, it needs act beyond our mandate when expectations rise further. We are facing a similar situation when the public expects more from monetary and financial sector policies than from fiscal policy.
Nepal’s financial system has also been laden with structural issues, including the poorly developed capital market, especially the bond market, the volatile nature of budgetary operations, and the overreliance of stakeholders on banking, both deposit and lending, then investing to or raising from, the capital market. While we need to make everyone bankable with better financial intermediation, support wings like the capital market also become equally important to better function as banking or monetary policy alone cannot shoulder this responsibility.
The NRB is working to strengthen cyber security, protecting from scams and data breaches, in the eve of growing financial digitalization. We have made substantial progress in digital payments and settlements but we need further work to ensure consumer protection and safety. Likewise, we are working further on interoperability within internal and external payments and settlements. For example, we are working extensively to establish a National Payment Gateway, and further easing international payments and settlement mechanisms. We are also studying new prospects like central bank digital currencies to cope with the digital era and enhance monetary transmission effectiveness.
NRB’s Provisions Facilitating NRN’s
Several provisions are put in place to facilitate NRN’s for making investments in Nepal. Some of them are:
The Role of NRNs to the Development Path
I see the two major roles of the NRNs in Nepal’s development aspirations. One, is investment generation and second, is governance and international best practices. As Nepal has a wider resource gap indicated by various documents, the NRNs can be a major source of filling this gap. The NRNs better know the risks, returns and opportunities and tap the potential easily.
Since the diaspora network is widespread and has made remarkable progress overseas, NRNs can bring a better corporate culture and follow the international best practices to Nepal’s development projects.
On behalf of the NRB, I have one humble request to all of you, please stop doing Hundi yourself and discourage others as well. When the senders skip the formal channel of international fund transfer, it actually distorts the overall financial and monetary channel and creates multiple problems. Therefore, the role of NRNs becomes immense to generate investments, and support the banking system’s liquidity by containing the Hundi, which ultimately leads to a better economic transformation path at least for one side. We are unfortunate that the Hundi is more massive in developed economies like Australia and the USA than the golf and Malaysia.
