The Monetary Policy for Fiscal Year 2024-25 issued last Friday by the Nepal Rastra Bank (NRB), the monetary authority of Nepal, is generally hailed as expansionary. Nepal’s stock market responded positively to it, triggering a bull run and circuit breaks on Sunday’s trade, the first day of trading after the policy announcement. The Nepal Stock Exchange Index crossed the 2,700 mark after 29 months.

The market seemed to have responded positively to the abolition of the Rs200 million ceiling to institutional investors in margin-type lending by the bank and financial institutions, an extension of the loan repayment period for the construction businesses by the end of December 2024, and provision for uncollateralised loans to those going for foreign employment, among others. These, indeed, are more reactive than well-thought-out sustainable policy responses that are unlikely to deliver desirable impacts on containing the severe recessionary trends faced by the economy.

Monetary policy-making

For decades now, Nepal’s monetary policy formulation has been a ritual orchestration rather than a substantive assertion of legally empowered independence by the NRB. The first compromise on monetary policy independence emanated from the fact that the Nepali currency is strictly pegged with the Indian currency. Pragmatically, the pluses of this arrangement may outweigh the minuses for the Nepali economy, so policymakers are not even considering discontinuing it.

First, according to the universally acclaimed monetary theory of the impossible trinity, “a country can’t have a fixed exchange rate, independent monetary policy, and free capital movement all at once”. This means that no monetary policy can be ‘independent’ as long as it is pegged with any other currency. But we continue to embrace this impossibility.

Second, the central bank shoulders three distinct responsibilities: Controlling inflation, ensuring financial sector stability through supervision and regulation, and, for all practical purposes, functioning as the government's key development finance agency. This reality has often obviated the NRB from an undivided focus on the 'core' central banking functions of money supply, inflation targeting and aversion to systemic risk.

Third, the monetary authority and the monetary policy it brings out are often burdened with undue expectations beyond their jurisdiction and capacity. For example, a monetary policy is expected to come out with stimulus packages to ‘rescue’ the economy reeling down the recession, which could be appropriately addressed only by a bold and creative fiscal policy. The monetary policy can only complement this endeavour by managing financial resources for the same.

Fourth and the saddest of all, the central bank is exhausting all its autonomy and energy in utterly un-innovative ritualisation of the tasks it should have shed decades ago. For instance, the directed lending policies in the name of the priority sector, deprived sector or the schemes aimed at financial inclusion should no longer be part of monetary policy since they may give rise to a conflict of interests between the roles of a regulator and concessional development financer. The most striking ambiguity of the sort is manifested in the NRB dilemma in dealing with microfinance institutions.

The misses

The Monetary Policy appeared as if the central bank was unaware of the current economic malaise and the sources of recalcitrant stagnation. One major sector where the banks have over-invested in the past and suffocated at present is real estate. Except for raising the credit limit from 50 to 70 percent of the valuation to the homeowners with a ‘proven tax file’, the policy has left the land and housing entrepreneurs completely at bay. With India reducing duties on gold imports by 9 percent, as announced in the country’s annual budget last week, the gold market in Nepal, for better or worse, is going to be impacted differently. It will have a bearing on both investment and foreign exchange reserves. The new monetary policy grossly overlooks this phenomenon.

Despite repeating a decade-old idea of setting up a second-tier oversight institution to regulate the saving and credit cooperatives and streamlining the operations of the microfinance institutions, the policy has blatantly failed to reinvigorate the small-and-medium-enterprise (SME) ecosystem. At present, the SMEs of Nepal face a grave crisis of legal/official recognition that has, in turn, impeded their access to formal financing mechanisms.

The Economic Census of Nepal 2018 has shown that out of 923,356 establishments, only 462,605, or 50.1 percent, are registered. The rest—49.9 percent—have no legal identity. These are important entities providing self-employment and livelihood support to a large population. However, they have hardly any scope to find sizable investments and scale up their operations to enable them to reap the benefits of economies of scale. Again, it must not be misconstrued that the central bank should be directly involved in financing these SMEs. However, as a policy-maker, it should make functional arrangements by engaging relevant stakeholders like the subnational governments to facilitate and recognise grassroots businesses. This reflects the glaring gap in the public policymaking mindset that devolved financial power under federal polity can help optimise implementation, including monetary policy.

Flimsy approach

Some haphazard and over-ambitious policies have only eroded the central bank’s credibility as the regulator. A provision not to blacklist the contractors deliberately issuing bank checks without adequate balance in their accounts is in direct contravention of the best universal practices in banking.

The monetary policy proposes to support the government in achieving an economic growth rate of 6 percent, as proposed by the budget of the current fiscal year, through liquidity management and credit disbursement towards the productive sector. It projects the broad money supply to be at 12.0 percent and credit disbursement to the private sector to grow at 12.5 percent. This means an increase of about Rs660 billion from the current Rs5.3 trillion disbursements of loans.

The target is clearly to invest about Rs700 billion worth of loanable funds now lying idle in the system. This is a huge ask considering that during 11 months of the last fiscal year, loans from banks to the private sector increased only by 5.1 percent.

The policy also fails to address the risk of alarmingly increasing non-performing assets in the banking system, making the banks more hesitant to invest aggressively. Such policy orchestration does not support the wider agenda of overdue structural reform of the financial system.