Easing its monetary policy, Nepal’s central bank, on Friday, lowered its interest rate to boost credit in the banking system and shore up private sector investments in a flagging economy.

Nepal Rastra Bank in its third quarter monetary policy review reduced the bank rate by 1 percentage point to address the ongoing economic crisis. The central bank lowered the rate to 7.5 percent from 8.5 percent.

A bank rate is the interest rate at which a nation's central bank lends money to domestic banks, often in the form of very short-term loans.

When the domestic banks get funds at lower rates from the central bank, they can subsequently lower the interest rates for their own borrowers, creating more demand for credit in the market, giving a boost to economic activities.

“The revised bank rate will help reduce the interest rates on both deposits and loans and it will also contribute to increasing the money supply in the market,” the apex bank said.

Lower rates lead consumers to borrow more, which also effectively increases the money supply.

Central banks use tools such as interest rates to adjust the supply of money to keep the economy on a growth trajectory.

The Nepal central bank’s move comes at a time when Finance Minister Prakash Sharan Mahat has been calling for the easing of the monetary policy in Parliament as well as other public forums in order to stimulate the struggling domestic economy.

Nepal’s economy is estimated to grow by just 1.86 percent in the current fiscal year as against the initial target of 8 percent, the National Statistics Office, said on May 2.

Sectors like manufacturing; construction; wholesale and retail trade, and repair of motor vehicles and motorcycles are all expected to suffer negative growth.

The monetary policy also announced providing refinance facilities to the sectors witnessing negative growth for two consecutive quarters of the current fiscal year. The limit of the refinancing amount has been reduced to Rs6 billion.

The central bank also said that due to the limitation in resources, the refinancing facility will be provided to only three sub-sectors of the economy.

According to the National Accounts Statistics, the construction sector, which contributes 5.52 percent to the gross domestic product, is estimated to drop 2.62 percent. During the last fiscal year, the construction sector had grown by 7 percent.

The retail and wholesale sector, which accounts for 15.39 percent of the GDP, is estimated to plunge 2.96 percent this fiscal year, the statistical office said. In the last fiscal year, the retail and wholesale sector had expanded by 7.46 percent.

The manufacturing sector is estimated to drop 2.04 percent in the current fiscal year, compared to a growth of 6.74 percent in the last fiscal year.

Nepal’s top private sector body—the Federation of Nepalese Chambers of Commerce and Industry said although the central bank has admitted underlying problems in the economy, there is doubt that the economy would recover immediately with such an inadequate response.

In a statement, the chamber of commerce said the rescheduling and refinancing scheme announced by the central bank was partial, indicating that it may not be enough to stimulate these sectors.

Krishna Prasad Adhikari, vice-president of the Confederation of Nepalese Industries (CNI), lauded the monetary easing on two fronts—reducing the interest rates and providing rescheduling and refinancing facilities—to bail out the economy.

“The central bank's decision to reschedule the loans of industries that have capital of Rs 50 million is a good move,” he said. “The refinancing facility for the affected sector will also provide positive stimulation to the economy.”

“However, for most of the small industries with a capital of Rs 100 million, it would have been better, if the central bank had provided the rescheduling facility,” said Adhikari, who is also chairman and owner of Agri Gear Nepal, the producer of biopesticide, micronutrients and biofertilizer.

“If it is not addressed on time, the manufacturing sector may collapse.”

Economists say most sectors are facing financial trouble and now the government through its fiscal policy needs to boost capital expenditure. There is also a need to increase employment through the upcoming budget, they added.

According to Nepal Rastra Bank, under the subsidised loan scheme, the government has disbursed Rs205.11 billion in loans to 147,807 creditors.

The outstanding refinance facility provided to agriculture, manufacturing, micro-enterprises, export-oriented and other sectors which were impacted by Covid-19 has come down to Rs5.77 billion as of mid-April 2023, after the repayment.

The central bank decided to continue refinancing facilities in certain sectors although it has a stated policy of winding down refinancing facilities being provided to the Covid-affected sectors.

In view of the slowing economy in the real sector, the quarterly monetary policy has decided to restructure and reschedule the loans provided by banks and financial institutions to hotels and restaurants, livestock rearing and the construction sector by analysing the cash flows of creditors by mid-July 2023.

The monetary easing by the central bank has come at a time when the International Monetary Fund has warned against monetary easing. It has been argued that as inflation has been on the higher side, monetary easing could push inflation over the roof.

The monetary policy said that in the 2022-2023 fiscal year, the average inflation seems to have breached the central bank’s target. “The average inflation which was 5.73 in the first nine months of the current fiscal year has jumped to 7.91 percent in mid-April of the current fiscal year. The year-on-year consumer price inflation remained at 7.76 percent in mid-April 2023, compared to 7.28 percent a year ago.”