The summer of Kathmandu, quite scorching these days, has recently witnessed the pork barrelling of the budget for the upcoming fiscal year 2023-24. The lucky escape from the fall into the abyss of economic quandary a year ago, nudged by the prudent central bank of the country—Nepal Rastra Bank (NRB)—via import restrictions policy, should have rung the bells for a much-needed structural intervention. But our castle of expectations has, once again, fallen.

The troika of economic disasters—the Covid-19 pandemic, global inflationary pressures and loanable fund crisis—has increased inequality in Nepal. But the concerns of inequality are unheard of and overlooked. The rural-urban divide, digital divide and class divide have all weakened the social fabric to a new low. This unabated inequality will be messier if not treated now.

Regarding inequality, the government is not the only agency to blame for this dilly-dallying; the central bank's number crunchers should share the pie too. Independent central banks are acknowledged as overseeing price stability and external sector stability to support sustainable economic growth, but they blatantly ignore externalities such as inequality and poverty. Some of these issues, which indicate the NRB’s high hand in raising inequality, are explored in this write-up.

Poor getting poorer

The paradox of our times is that the financial system charges absurdly high-interest rates to the poorest people, who lack sufficient assets/income to pledge as collaterals and minimal rates to the wealthy ones. Citing reasons such as risk-based pricing, credit history, and collateral-based pricing, interest rates charged on credits forwarded to marginalised people are significantly high.

The NRB has broadly classified banks and financial institutions into four classes: A, B, C and D; they form commercial banks, development banks, finance companies and microfinance institutions, respectively. Their scope of operation narrows, and their rural penetration broadens while moving from A to D in the hierarchy. But the cost of funds from A-class banks, mostly relying on urban areas, is low vis-à-vis the cost of funds from B, C and D-class banks, which mostly cater to the rural clientele.

Furthermore, the central bank’s conceptualisation of “intermediary of the intermediaries (banks)” in the name of microfinance institutions (MFI) adds insult to injury. Though the NRB has barred them from charging interest rates greater than 15 percent per annum, the effective interest rate, including upfront fees like service charges, renewal fees and indirect costs (cost incurred in reaching the MFI’s physical premise for service), are exorbitantly high, ranging from 25-30 percent per annum. It shows that the central bank’s conceptualisation of the current banking and financial institutions' structure is outrightly assembling inequality. This should never have been the case for the so-called “socialism-oriented economy”.

Capturing concessional loans

One of the most painful facts being witnessed in recent times is big business houses misusing concessional agricultural loans allocated for poor farmers. The NRB has mandated A-class banks to forward at least 11 percent of their credit to the agricultural sector by mid-July 2023. Though credit flows to the agricultural sector have already exceeded the set benchmark in terms of figures, they have merely contributed to the gross domestic product. A huge chunk of credit has been directed to the agricultural sector, but the annual growth of the agricultural sector has averaged only 2.95 percent for the last 10 years (CBS, 2023). This clarifies the misuse of the funds. The trend of establishing a subsidiary, digging a pit, throwing a thousand baby fish in a pool, getting a couple of crores of concessional loans, and misappropriating funds in real estate has been the real riddle of the entire system.

Similarly, the subsidised women entrepreneurs' loan, advanced by the central bank’s provision, has been captured by the elites who do not necessarily need the loan. The credit flowed to clients without a proper need assessment. Also, it lacked strict provisions for routine inspection to ensure the proper utilisation of the realised funds. The same has been true of subsidised credit provided to trekking guides, released immediately after the Covid-19 pandemic. So, when the central bank does not stringently regulate these concessional credits, state-of-the-art policies often tend to become counterproductive and a burden, further widening the inequality gap in the process.

Rural deposits, urban credits

A significant factor reinforcing the rural-urban divide has been the excessive investments of rural deposits in urban areas. Remittance inflow has significantly increased in rural areas, increasing deposits in the rural branches of banks. As banks must maintain an overall credit-deposit ratio of 90 percent, they disburse credit based on the overall volume of deposits collected nationally.

However, branches in the rural sectors are just like deposit collection centres. The proportion of credit flowed by rural branches in the local area is minimal in most cases. Citing the reasons for an insufficient collateral base/income level, credits are not disbursed in the rural sectors, from where deposits have been collected. The officers of private banks often cite the low demand for credit from rural areas as the cause of this unequal disbursement of funds. However, some provisions, though flexible ones, should be introduced to maintain branch-wise or region-wise credit-deposit ratios.

Hitting the poor hard

Prior studies have shown that high inflation hits the poor harder since businesspersons and industrialists can increase the price of their outputs in line with inflation, but the labour wage rate takes much more time to adjust. Next, the poor mostly spend all their incomes on necessities, which is mandatory for their survival, and a rise in the price level means a fall in the number of goods consumed. But the rich can easily curtail their consumption of luxury items for some time. Furthermore, the compensation of government employees seldom increases on par with price level, citing the inflationary impacts on the economy. This creates a huge pay gap between private and public institutions. This means that if the NRB fails to limit inflation within the target range, it will fuel inequality.

Being an independent central bank, the NRB must take a great leap to transform the structural inequality ingrained in the existing financial system. The central bank should reassess the existing classification of banks and financial institutions and ensure a low cost of funds for the marginalised. Next, it must develop a stringent supervision mechanism to guarantee the optimal utilisation of concessional loans. They also should study whether the lack of credit flowing in rural areas is causing massive de-ruralisation and make policy interventions accordingly. Lastly, if the NRB seriously dedicates itself to its all-time objective—taming inflation—it would help the poor live a decent life. The over-concentration of credits in urban cities must be checked if we aim for rural development.