The current key financial indicators in Nepal are highly paradoxical and worrisome. According to the latest data released by the Nepal Rastra Bank, the central bank of Nepal, deposits in banks and financial institutions (BFIs) have crossed the Rs6.16 trillion mark, while credit disbursement is Rs5.12 trillion. These two figures are 108 and 92 percent of Nepal's estimated Rs5.7 trillion gross domestic product (GDP), respectively. This means that even after maintaining mandatory cash ratios with the central bank—which amounts to around Rs3.6 trillion in aggregate—about Rs6.5 trillion is available as loanable liquidity in the banking system. This, indeed, should have been a god-sent historical opportunity to catapult Nepal to the next level of economic activities and growth. Sadly, that does not seem to be on the anvil.

Now, the loan uptake by the entrepreneurs and investors is very slow. The credit growth is 2 percent slower than the deposit growth. The effective interest rate is still in double digits, hovering between 10 to 12 percent. For small borrowers who generally rely on microfinance institutions and credit cooperatives, the cost of funds is at least 20 percent. High interest rate is apparently one of the key deterrents to potential borrowers. Also, a higher amount of deposit collection compared to loan disbursement is taking a toll on the profitability of the BFIs.

On one hand, despite most BFIs’ favourable loanable liquidity position, they are unwilling to cut the interest rate for fear of a further decline in profitability. Such practices blatantly compromise the principle of price determination in a free and complete market based on the quantity of funds demanded and supplied.

On the other hand, non-performing loans (NPL) of the BFIs are rapidly growing. The total NPL was 3.6 percent of the total loan disbursement last January, which has now risen to 4.8 percent. In nominal terms, approximately Rs250 billion worth of loans is slipping into the risky zone. As its obvious aftermath, the number of borrowers blacklisted for their default on timely repayment is reported to be about 200 per day. This inescapable trap to businesses is created due to the growing number of business closures and increasing financial losses in those businesses struggling to survive.

Economy in recession

Technically, a recession is defined as a decline in GDP growth for two consecutive quarters. However, to the great relief of the ruling political leaders and bureaucracy, Nepal does not produce quarterly GDP growth data. If the annual growth forecasts like the recent ones from the World Bank and the Asian Development Bank, which predicted Nepal's growth rate to be no more than 4 percent in 2024, are to be trusted, Nepal is clearly in a recessionary trajectory. Other disappointing trends in real income, industrial output, employment rate, wholesale and retail sales and overall service sector performance confirm that the economy went downhill in several successive quarters to arrive at this stage.

Other rather subjective but evident recession traits are manifested in the form of pervasive plummeting of the consumers' confidence, investors' confidence, overall market confidence, and trust deficit on the incumbent government's sincerity as the principal agent supposed to work for the economic betterment of the country.

The gaps

The economic revival looks challenging even in several years if the government fails to take bold countercyclical measures, mainly in revenue collection, capital expenditure and implementing fiscal federalism. And the monetary policy must improve corporate governance in the banking sector, which private sector players dominate by more than 90 percent. This is exactly where effective coordination between fiscal and monetary policies is indispensable.

On the fiscal policy side, if the tax policy to find new revenue sources is not comprehensively recalibrated, the collected revenue, like in recent years, will continue to fall short of even meeting the current expenditures, let alone augmenting the capital expenditure and saving the country from default on sovereign debt servicing. The capital allocation in the federal budget is pathetic, persistently at less than 20 percent of total earmarks. Worse, the spending capacity has effectively come down to about 40 percent of even such a low allocation.

Despite federalism devolving the constitutional authority to sub-national levels to devise 'their own' public procurement laws, timely completion of contractual procedures of the projects has been extremely tardy. The complications are added by the vested interests of the people in executive power in awarding contracts with apparent conflict of interest.

When the government, as the single largest procurer, fails to spend its capital budget transparently, the cash flow in the financial market is bound to shrink. This has direct ramifications on the liquidity positions of the BFIs. The persistent failure of the governments at all three tiers to carry out the capital expenditure as outlined has a cumulative adverse impact.

Trust the system

A sincere effort to put fiscal federalism into practice in the true spirit of the federal polity and state architecture will certainly solve several critical issues related to fiscal resource management at the provincial or municipal levels. For instance, reasonably effective management of the bond market at the centre helps generate resources for development expenditure. In allocation, the disbursement may be proportionate to the absorption capacity of an individual administrative unit like a ministry or a federal unit like a municipality. This would ameliorate a number of pending constraints faced by the entire financial system of the country. It is already too late to consider the legislation to empower competent municipalities to issue their own development bonds so as to enhance the fiscal policy independence of the local governments and increase the stakeholder ownership of the executed projects.

To conclude, two critical steps are inevitable to rescue the economy from the brink of a deeper recession. One, a stimulus package with an amalgam of fiscal and monetary incentives is necessary. The business-as-usual budget will not solve new challenges to the economy, like the rapidly depleting base of state income. Two, the impending credit risk in BFIs will be far larger if the businesses are not put back on track by enabling them to unlock their full potential, now an existential threat due to the engulfing recession.