Kathmandu, Oct 31

The International Monetary Fund has called on Nepal to accelerate banking sector reforms stating provisions on loan classification, loan-loss provisioning and risk management are not adequate to weather rapid credit growth.

A loose monetary policy and the mandatory central bank requirement for four-fold increase in paid-up capital of commercial banks have fostered rapid credit expansion, with private sector lending growth averaging 22 per cent in the past two years. The central bank has lately tried to curtail flow of credit towards unproductive sectors by revising loan-to-value ratio on car and real estate loans. Yet a big chunk of credit is going towards these sectors.

“Rapid credit growth underscores the need to accelerate banking sector reforms,” says the IMF’s latest South Asia Regional Update, adding, “Loan classification, provisioning, and banks’ risk management practices should be upgraded.” The IMF has long been saying that high credit growth tends to increase cases of loan defaults, creating risks in the financial sector. It has therefore been prescribing that credit expansion take place in a sustainable manner. But others argue slow credit expansion could hit economic growth.

Nepal’s economy has made impressive performance in the last two years, with growth rates standing at eight per cent (market price) in fiscal year 2016-17 and 6.3 percent in 2017-18. “Above-trend growth has been supported by two successive favourable monsoon seasons, accommodative fiscal and monetary policy, a pickup in [post-earthquake] reconstruction activity, and markedly improved electricity supply,” says the IMF report.

But expansionary fiscal policies that have aided growth have also fuelled imports, prompting Nepal to record current account deficit of 8.2 per cent of the GDP in 2017-18. This has caused the gross central bank foreign exchange reserves to shrink to US$9.7 billion in September from $10.1 billion in July.

A growing current account deficit--which indicates higher outflow of money from the economy--has also put a strain on budgetary operations of the government with fiscal deficit standing at over six per cent of the GDP in 2017-18. The fiscal deficit was triggered by large transfers to local governments and a further increase in capital spending. As a result, public debt rose for the first time in many years, to a still-manageable 29.7 per cent of GDP.

“The fiscal deficit could widen further in 2018-19 with the ongoing implementation of fiscal decentralisation, unless the government continues the strong revenue collection effort seen in the first two months of this fiscal year when revenues rose by 36 per cent year-on-year,” says the IMF report.

The IMF has said Nepal’s near-term challenges are to ‘maintain the recent growth momentum and create conditions for sustained high and inclusive growth’. “Efforts should focus on strengthening key institutions and administrative capacity to boost private investment and growth,” says the report, adding, “Fiscal policy should focus on higher and better-quality public investment and prudent implementation of fiscal decentralisation through sustainable intergovernmental fiscal arrangements and the need to build public financial management capacity at the sub-national level.”

Hasty implementation of fiscal decentralisation, according to the IMF, could strain government finances and weaken fiscal policy’s stabilisation function. “At the same time, with the fiscal stance having become more expansionary than in previous years, monetary policy needs to be tightened to keep inflation and balance of payments pressures in check,” says the IMF report.