The instant reaction to the Monetary Policy for Fiscal Year 2024-25 has been celebratory for the most part. How it will be judged in months and quarters to come remains to be seen. For now, the stock market has spoken. The Nepal Stock Exchange (NEPSE), which had already been rallying feverishly since early July, surged by 4.4 percent on July 28—the first day of trading after the Nepal Rastra Bank (NRB), the country’s central bank, published the policy on July 26. The NRB has drawn accolades for adopting an expansionary policy. It lowered the benchmark interest rates, scrapped the Rs200 million margin-loan cap for institutional investors and reduced provisioning requirement for banks, among others.

Stocks particularly reacted to the removal of the margin-loan ceiling for institutional investors. A brief history is in order: Three years ago, the 2021-22 monetary policy limited margin loan per customer to Rs40 million at one bank and Rs120 million at multiple banks. The NRB aimed to rein in the prevailing massive investor speculation back then. Soon after, the NEPSE tagged 3,227 in August 2021 and headed lower. The snorting bulls were up in arms and put all kinds of pressure on the Maha Prasad Adhikari-led central bank to roll back the cap, to no avail. Last October, the Rs120 million ceiling was upped to Rs150 million for individual investors and Rs200 million for institutional investors.

Fast forward to now, and the cap for individual investors remains, but a limit no longer binds institutional investors. They can borrow as much as they wish. The NEPSE shot up by 35.5 percent in July to reach 2,761. Earlier, soon after it peaked in August 2021, it was rangebound between 1,800 and 2,200 before it broke out in the middle of last month. The July move looks parabolic, but volume is fully cooperating. As of mid-June, banks and financial institutions (20 commercial banks, 17 development banks and 17 finance companies) held Rs87.1 billion in margin loans, up from Rs76.5 billion as of mid-July last year. It is safe to assume that the latest monetary policy will embolden investors to take on additional leverage.

Setting bad precedent

Leaving aside the fact that leverage cuts both ways and contractions in leverage will hurt stocks, the current market momentum is up, and leverage can be beneficial. The NRB should closely monitor how the current bull will evolve and what kind of speculative mania this will spawn. Three years ago, the NEPSE continued to rise non-stop for over two years before it reached a record in August 2021. More important is whether the NRB leadership will have the willingness and the courage to tackle a scenario in which excessive leverage risks hurting investors and/or the economy. In this regard, Governor Adhikari withstood undue pressure from even former finance ministers who wanted looser margin-lending rules.

Yuba Raj Khatiwada, the current economic adviser to Prime Minister KP Oli and former NRB governor, vice chairman of the National Planning Commission as well as finance minister, was one of several former finance ministers to openly call on the NRB to remove the margin-loan cap last year. Whether last month’s lifting of the Rs200 million cap for institutional investors was done at the sole discretion of the central bank or Khatiwada had a hand in it, we don’t know. This much we do know: The monetary policy, originally scheduled to come out on July 19, was delayed by a whole week. Apparently, on July 18, Khatiwada wanted to study the policy and borrowed it, causing the dillydally. This sets a bad precedent.

According to the Nepal Rastra Bank Act 2002, (1) The objectives of the bank are (i) To formulate and manage monetary and foreign exchange policies in order to maintain price and balance of payment stability for the achievement of economic stability and sustainable development of the economy; (ii) To raise public confidence towards the banking and financial system by making the sectors stable and by increasing access to financial services; (iii) To develop a secure, healthy and efficient payment system. (2) The bank, without any prejudice to the objectives referred to in subsection 1, will extend cooperation in the implementation of economic policies of the government of Nepal.

Restore central bank credibility

The Act also states that the bank shall be an autonomous and corporate body with perpetual succession. Sub-section 2 nonetheless creates room for government intervention, particularly considering that the bank’s seven-member board of directors comprises the governor, two deputy governors, secretary at the Ministry of Finance and three others appointed by the government. If the newly appointed prime minister wanted to review the monetary policy, he should have done so via Finance Minister Bishnu Poudel. The Act states that any contact between the bank and the government should be made through the Ministry of Finance. It was wrong for Khatiwada to interject himself into this.

Internal politics within the Oli-led NPC-UML may have played a role. Bishnu Poudel is the party's vice-chairman, while Shanker Pokharel is the general secretary. The two locked horns in July, trying to instil their loyal for the position of chief minister of Lumbini Province. In the end, with Oli’s blessing, Pokharel’s candidate won. It is logical to assume that Poudel and Khatiwada have different priorities for handling the stock market/economy. This, however, cannot justify Khatiwada’s intervention. The optics are jarring. Good governance, the rule of law and the end of corruption are some catchphrases thrown around in the Oli-led coalition government. Khatiwada’s faux pas is anything but good governance.

Central banks live or die by credibility. The NRB’s primary responsibility is to carry out monetary policy. Fiscal policy falls under the purview of the government. By nature, politicians are driven by the next election cycle and would like good things—such as rising stock prices—to unfold during their time in power. In contrast, the NRB, as a regulator, cannot and should not wish for higher or lower prices; rather, it should focus on creating a durable investing environment. Bringing out a monetary policy a week later than the scheduled time does not help boost the confidence of foreign investors, largely because this was due to government intervention. Let the “independent” NRB stay independent.