'Headline inflation has declined, but the stickier components remain persistently high. Central banks must continue to fight high inflation now, while also determining if- and how-monetary policy strategy may need to change in the future.

This is, of course, no easy task. I will focus on how to contend with high inflation by confronting what I will call three uncomfortable truths for monetary policy. The first uncomfortable truth is that inflation is taking too long to get back to target. This means that central banks, including the European Central Bank, must remain committed to fighting inflation despite risks of weaker economic growth.

The second uncomfortable truth is that financial stresses could generate tensions between central banks' price and financial stability objectives. Achieving 'separation' through additional tools is possible, but not a fait accompli.

The third uncomfortable truth is that going forward, central banks are likely to experience more upside inflation risks than before the pandemic. Monetary policy strategies and the use of tools like forward guidance and quantitative easing must accordingly be refined.'

(Remarks by IMF First Deputy Managing Director Gita Gopinath for the European Central Bank Forum on Central Banking 2023)

And Nepal Rastra Bank (NRB) – the central bank of Nepal – is preparing the Monetary Policy for the next fiscal year 2023-24 with an aim to crack the whip on inflation that it has failed to do in the current fiscal year.

Though NRB claims that inflation has been slowing down in the recent months, inflation is still above the Monetary Policy target. The reason is obvious, Nepal not only imports inflation from its southern neighbour but its Monetary Policy also fails to work due to the open border.

According to the NRB's Current Macroeconomic and Financial Situation of Nepal, based on 10 months' data, the Consumer Price Index(CPI)-based inflation remained at 7.41 per cent on year-over-year basis. It means the cost of goods rose by 7.41 per cent yearover-year. The Fiscal Policy (budget) and the Monetary Policy for the current fiscal year 2022-23 has targeted to limit inflation to below 7 percent. But it seems the Fiscal and Monetary Policy, both, failed to control inflation as the average inflation in the 10 months of the current fiscal year stands above 7 per cent.

NRB claims that inflation is cooling down because the year-over-year CPI stood at 8.26 per cent in the first month of the current fiscal year and in the tenth month (mid-May 2023), it was 7.41 per cent. However, the bitter truth is that inflation has never been below 7 per cent, which raises the question of the effectiveness of the Monetary Policy.

Thus, fighting inflation is easier said than done for NRB. And the textbook prescription of keeping the interest rate higher to pull inflation down has also been debated, not only in Nepal but also in the US and UK since the last one year, following the Russia-Ukraine war.

Theoretically, increasing interest rates will encourage people to spend less and save more, which reduces demand for goods and services and helps contain inflation. And NRB also did follow the theory ritually. But the tool has failed to keep inflation below the target largely due to external factors.

NRB is blamed for squeezing demand, and also the economy, by increasing the interest rate. Rather, a fall in aggregate demand in the market, due to higher interest rates, has been blamed for pushing the Nepali economy towards recession.

But the Monetary Policy has its own limitations compared to the Fiscal Policy (budget). It has long been realised that there are structural problems in the Nepali economy, which have to be addressed with bold moves by the government of the day through economic reforms. The remittance-dependent import economy cannot sustain for long, if the government is not serious about reforms.

Likewise, the NRB also has to be forward looking and start financial reforms through the Monetary Policy for the next fiscal year. The reforms can be started with the formation of a Monetary Policy Committee, which will concentrate on the policy rate and inflation. Inflation being the core issue, and for a country like Nepal that has witnessed no increment in the per capita income, it's even more serious.

The National Statistical Office (NSO) has projected that the per capita income of the Nepalis will witness no increase for the current fiscal year, which stand at $1,399, equal to last fiscal year's. But neither the government through the fiscal policy nor the central bank through the monetary policy has been able to control inflation. No increase in income but continuous increase in the cost of goods is making the lives of the Nepalis miserable.

As IMF's Gita Gopinath said at the Forum on the 'Three Uncomfortable Truths for Monetary Policy', NRB, being the central bank of Nepal, must not only continue to fight high inflation, but also start pushing for financial reforms.

The incumbent governor, Maha Prasad Adhikari, will get a chance to bring yet another monetary policy next year before retiring.

It's high time he dared to bring some financial reforms for a better business and economic environment for Nepal in the coming days. He should even dare to push for an amendment of the Nepal Rastra Bank Act to form the Monetary Policy Committee.

If we are to believe that the first phase of the financial sector reform in the 1980sopened up the banking sector to foreign investors, whereas the second phase in 2000 helped enhance the efficiency of the system and strengthen the stability of the system, now, after 23 years, its time the third phase of reforms were initiated, and old laws like the Banking Offence and Punishment Act, 2064 were amended to address the current challenges. Also some new institutions like the Monetary Policy Committee and Assets Management Company should be created to make the financial sector more efficient, inclusive, and risk-resilient.

A version of this article appears in the print on July 6, 2023, of The Himalayan Times.