The Economist on July 9 published a story on Buy Now Pay Later (BNPL), a new financial instrument designed to attract young people with limited credit histories to use credit cards in the consumer market. The instrument is an installment-based payment system introduced by financial innovators.

In Nepal, where issuance of credit cards to consumers is less than 1 percent of the total account holders, BNPL is irrelevant. Household consumption growth in the last three years hovered around 1 percent only. The rise of consumers’ demand for non-essential goods and services has been an abysmal post-Covid-19 pandemic.

In the meantime, bank interest rates on deposits have gradually declined to a negative rate (saving deposit interest is around 2.75 percent while the average annual inflation rate was 4.06 percent in 2081-82) which has affected middle-class consumers’ ability to buy in the market. Their disposable income has declined sharply over the last three years. Wage and salary growth rate is below the inflation rate.

The government is unable to spend its capital budget even as cash surpluses accumulate in state coffers each year. Nepal is said to be in a liquidity trap, as lowering the lending rates has stopped attracting more demand for funds from banks. Banks have crossed their red lines with the rise in non-performing loans (NPL), which now account for almost 5 percent of total lending.

Nepal is facing a paradoxical situation where interest rates have dipped, and inflation is relatively low, but the economy displays no surge in credit growth or consumption. Meanwhile, middle-class depositors feel squeezed because their deposit earnings, which is a key source of disposable income, have dropped heavily in the last two years. They have cut back on consumption due to income pressures, outmigration and low employment.

Banks are cautious about lending because they struggle with non-performing assets. Policy instability, weak capital market and regulatory unpredictability have also discouraged investments. Slackness in the construction sector, holding payments by the government and saturation of real estate have also slowed demands for new loans.

Middle-class depositors find no respite in seeing the double-digit interest rate on their fixed deposit earnings crumble down to 4 percent while household expenses still escalate. Labour compensation has not kept pace with inflation, especially in essential sectors such as education, medical care, transport and food. Social security payments have not seen increments. Earlier, deposit interest was a comfortable supplement to remittances and salaries. With that income stream dissipating, households have started saving more to compensate for their wealth loss—reducing their consumption and triggering a paradox of thrift. Nepal is stuck in a structural trap with low demand, weak business activity and low credit demand, perpetuating further declines in deposit rates, middle-class income and consumer demand.

In this scenario, fiscal measures need to be adopted to break the cycle and bring the economy back to a high growth trajectory. Average households’ propensity to consume needs to be enhanced by encouraging the public to go shopping. This will improve the mood of retailers, wholesalers and producers in the market, and raise their willingness to borrow, invest, produce and sell more. A four-pillar policy framework is suggested below to help build market confidence maintaining growth and investments, thereby utilising the excess liquidity.

Pillar 1: Growth of the consumer market

Consumer lending needs to be promoted through a rapid expansion of consumer credit cards, with a focus on penetrating the lower middle-income class. Commercial banks should distribute credit cards to everyone by loosening the initial offer criteria, similar to those for obtaining debit cards. The Nepal Rastra Bank should issue policy guidelines to help the growth of the consumer credit market. Schemes like Buy Now and Pay Later (BNPL), instalment sales and purchase hire should be encouraged. The government needs to pump more money into consumers by increasing their disposable income. This could be done by increasing income tax thresholds, releasing payments to contractors, expediting social security and Covid-insurance payments, executing the universal health insurance policy effectively and making the public education system affordable and of high quality.

Additionally, the government should focus on lowering the Value Added Tax (VAT) rate and removing specific tax exemptions. It should also harmonise and integrate federal and subnational taxes to avoid a cascade of taxes, and provide a sense of social protection, so that middle-class households don’t feel the pressure to save more and consume less.

Pillar 2: Banking and capital market reform

The non-performing assets of commercial banks have risen to a level that restricts large scale lending. This has left them tied up in restructuring old loans despite having significant loanable funds available at low interest rates. The central bank has kept mopping up such liquid funds regularly for short periods. This is not a long-term solution.

The NRB should eliminate the liquidity by investing in procuring bad assets of the banks through an asset management company, and release funds for fresh lending. Commercial banks need more prudence and discipline in BNPL management. They should be able to lend based on project quality and credit history. The financial sector and capital market need structural reforms to enable capital acquisitions for mega (multibillion USD) investment projects in non-conventional areas like fertiliser production, data mining and IT hubs. Development of the bond market for capital investments can be a good financing source for mega projects and the utilisation of excess liquidity with the banks.

Pillar 3: Capital budget execution

Immediate attention is required to enhance the pace of capital expenditure growth. The growth has been slowed down by a lack of incentives to performers and the fear of corruption allegations. An integrity framework is vital to promote and advocate good governance practices. The public procurement system needs immediate reforms based on good practices of transparency, economy and competitive bidding. Process reforms are needed for the rapid execution of projects, especially in areas of project screening, result monitoring, land acquisition, environmental impact assessment, forest clearance and getting supplies in time. The government should increase investment in projects that give quick returns and increase employment opportunities in urban areas to induce youth to earn and consume here.

Pillar 4: Investment climate

Investment climate should be an actionable priority to increase the demand for investible funds which lie idle in the financial sector. Reforms that guarantee policy predictability and stability, good governance, low compliance costs, better exit and entry policies, dignity to the private sector, fair tax administration with low tax rates, procedural simplification and profit repatriation with attractive returns would significantly enhance the investment climate. Such measures would improve the ease of doing business far more effectively than merely maintaining painfully low bank interest rates.