Monetary targets

• Inflation - 7.5 per cent
• Money supply growth - 17 per cent
• Growth in lending to private sector - 20 per cent

Kathmandu, July 14

Depositors, who complain about losing money by parking their savings in banks because of negative real interest rate, and borrowers, who gripe about sudden hike in lending rates, may get some respite in the coming days, as Nepal Rastra Bank (NRB) is all set to make a strategic shift in monetary operations by introducing interest rate corridor.

This is the main highlight of the Monetary Policy of Fiscal Year 2016-17 launched today by NRB, the central bank.

Interest rate corridor, or IRC, is a mechanism that guides short-term market rates and helps keep all interest rates within certain band, reducing interest rate volatility. This means introduction of IRC will provide clear signals to bankers, policymakers, borrowers and depositors on how short-term interest rates will move in the market, enabling them to make decisions accordingly.

This is ultimately expected to benefit end depositors and borrowers, who are tired of dealing with sudden drop or hike in interest rates.

“We are introducing this mechanism in the next fiscal year as it is being used worldwide to reduce interest rate volatility. We believe this mechanism will modernise our monetary operations,” NRB Governor Chiranjibi Nepal said, launching the Monetary Policy for the next fiscal year, which is beginning on Saturday.

Once IRC is introduced, NRB will shift from ‘quantity-based operating target to interest-based operating target in monetary operations’, according to Nara Bahadur Thapa, executive director at the Research Department of NRB.

NRB is currently using money market instruments to mop up liquidity from and inject liquidity into the banking sector. But interest rates on these instruments, such as repo or reverse repo, outright purchase or sale auctions, and term deposit, are determined through auctions, meaning they are not fixed. As a result, rates have dropped below one per cent due to excess liquidity in the banking sector.

IRC at a glance

• Standing liquidity facility rate to work as ceiling rate of interest rate corridor
• Two-week repo rate, or policy rate, to be fixed by adding 200 basis points, or two percentage points, to weighted average interbank rate of commercial banks of two working days ago
• Two-week term deposit rate, or floor rate, to be fixed by deducting 10 basis points from weighted average interbank rate of commercial banks of two working days ago

Once the new mechanism is introduced, instruments floated by NRB to keep IRC functioning will come with fixed interest rates and will be extended to banks and financial institutions (BFIs) on proportional basis — albeit rates on other money market instruments will be fixed through auction as in the present day.

To keep IRC running, NRB will basically take support of standing liquidity facility, two-week repurchase (repo) facility and two-week term deposit facility.

Standing liquidity facility, under IRC, is a mechanism to provide loans to BFIs for a maximum of five days in case there is severe shortage of cash. NRB provides this credit on back of collateral, such as bonds and other securities issued by government and NRB.

The annual interest on this loan is currently fixed at seven per cent. This interest rate, which can fluctuate over the time, will work as the ceiling of IRC.

The floor of IRC, on the other hand, will be created using the interest rate fixed on two-week term deposit facility.

The term deposit facility is an instrument that NRB uses to absorb, or borrow, money from BFIs. Under IRC, term deposit rate would be fixed by deducting 10 basis points, or 0.10 percentage point, from weighted average interbank rate of commercial banks of two working days ago.

In between the standing liquidity facility rate and two-week term deposit rate will lie two-week repo rate.

This repo rate would be fixed by adding 200 basis points, or two percentage points, to weighted average interbank rate of commercial banks of two working days ago. This rate, according to NRB, will function as the policy rate, or the rate at which NRB will extend loans to BFIs for a period of up to two weeks. This credit will be extended on the back of collateral, according to NRB.

It is now almost certain that there will be huge difference between three different sets of interest rates, once IRC is introduced.

This is because standing liquidity facility rate, or the ceiling rate, is currently fixed at seven per cent, while term deposit rate, or the floor rate, will hover around 0.9 per cent, considering latest weighted average interbank rate of commercial banks of one per cent. If this interbank rate were to be taken into account, then the policy repo rate would stand at three per cent.

Generally, the wedge between ceiling and policy rates, and policy and floor rates should not be so wide.

And this is what bankers are concerned about.

“We were asking NRB to introduce IRC to ensure interest rate stability and provide some respite to depositors who are getting low returns. But IRC proposed by NRB is not likely to address these issues because policy repo and term deposit rates are being fixed on the basis of weighted average interbank rate, which always remains depressed in Nepal because of shortage of high-yielding money market and debt instruments,” Sanima Bank CEO Bhuvan Kumar Dahal said. “So, we urge NRB to work towards raising term deposit (or floor) rate and ensuring the gap between floor, policy and ceiling rates is not wider than 100 basis points.”

Said NRB Executive Director Thapa: “We are cautiously taking steps as we are moving into uncharted waters. But there is scope for further improvement and it will depend on how market participants will react.”

Forex facilities

• Traders importing goods via third-countries using instruments like draft and telex transfer to be extended foreign exchange facility of up to $50,000 for one-time payment
• Traders buying software from India allowed to acquire one-time letter of credit worth up to $15,000 from existing $10,000
• Nepali foreign currency account holders allowed to purchase goods and services worth $15,000 per year from abroad

Other highlights

• Loan-to-value (LTV) ratio for commercial real estate reduced to 50pc from existing 60pc; LTV ratio fixed at 60pc for residential housing
• Ceiling on consortium financing raised to Rs 1bn from existing Rs 500m
• Interest spread for microfinance institutions fixed at 7pc
• Commercial banks directed to channel 15pc of total loans towards agriculture and energy sectors from existing 12pc
• Investors interested in building luxury hotels in underdeveloped tourist destinations such as Pathibhara, Mai Pokhari, Halesi, Langtang, Swargadwari, Upper Mustang, Gadimai, Janakpurdham, Rara and Khaptad to be provided refinancing facility at 4pc interest
• Commercial banks directed to bring down portion of institutional deposits to 50pc of total deposit, from existing 60pc
• BFIs barred from extending over 50pc of share’s average final value of last 180 days or current market price of the stock, whichever is lower, as margin loan
• BFIs directed to allocate at least 1pc of profit to fulfil corporate social responsibility
• BFIs directed to allocate at least 3pc of gross staff expenses for training and human resource development
• Over Rs 3m of financial transactions to be conducted through cheques; previous ceiling stood at Rs 5m
• Microfinance development banks directed to raise minimum paid-up capital to Rs 600m within mid-July, 2018

‘Not the first time’

This is not the first time Nepal Rastra Bank has come up with the idea of introducing interest rate corridor (IRC). NRB had made an announcement to introduce this mechanism during the tenure of previous governor Yubaraj Khatiwada. But the plan was never implemented.

The difference this time is that the Monetary Policy for the next fiscal year incorporates a detailed plan on how the IRC would function, which has raised hopes for its early implementation.

To introduce the IRC, NRB will now direct the Open Market Operation Committee to draft a guideline, which will have to be endorsed by the board of NRB, before it comes into effect.

“If things go according to plan, we will make all preparations to introduce IRC within a month of commencement of new fiscal year,” NRB Deputy Governor Chinta Mani Siwakoti told The Himalayan Times.