‘Investment cycle has stalled in Nepal’

Consumer prices rose by 9.7 per cent in Nepal in April. While supply-side constraints play a key role in making goods expensive here, inflationary pressure in India also pushes up prices in the country. This is because over 60 per cent of the goods consumed in the country are imported from India. So, impact of price hike in India is automatically passed onto Nepal. Lately, the weakening of Nepali rupee is also contributing to inflation because devaluation of the currency against the US dollar makes goods expensive in a virtually net-importing country. But Nepal does not have control over movements of its currency because it is pegged with the Indian rupee. In this regard, Rupak D Sharma of The Himalayan Times caught up with Ananth Narayan, newly elected Chairman of Standard Chartered Bank Nepal and Regional Head of financial markets for ASEAN and South Asia, Standard Chartered Bank, to discuss outlook on Indian inflation, rupee movements and Nepal’s banking sector and capital market.

What do you think of the growth of Nepali banking sector?

Nepal’s economy has a huge potential. The country is blessed with natural resources, industrious people and one of the youngest populations in the world. As the economy grows and realises its potential, the banking sector will have a larger role to play. First, the money needs to go into the infrastructure sector, where a huge gap has been identified. Since Nepal’s capital market is in a nascent stage, channels also need to be created to convert savings into infrastructure investment. So, banks need to play a huge role there. At the moment, earthquakes and blockade (on Nepal-India border points) have caused economic growth to decelerate. This has affected the banking sector as well. But we are hopeful about economic activities picking up in the coming days. This will automatically result in growth of the banking sector.

You just said Nepal’s capital market is in a nascent stage. What do you think should be done to make it more sophisticated?

Capital market isn’t an end in itself. In fact, every country grows without a capital market. So, in the absence of a capital market, banks are normally the only conduit that channel savings into infrastructure projects. So, converting savings into productive investment is more important. It is very surprising that consumption, and not investment, is looking robust in Nepal — although the country needs to ramp up infrastructure investment. Nepal needs energy projects, roads, airports and railroads to become self-sufficient and provide employment to young people joining the jobs market. Also, infrastructure is needed to manage inflation and give a boost to economic growth. But to stimulate investment in the infrastructure sector, you need long-term funds of 10, 15 or 20 years. Since Nepal does not have a well-functioning capital market and banks typically get money for a short term from depositors, long-term credit is hard to find. Of course, multilateral organisations, such as the World Bank and the Asian Development Bank, always support some of the infrastructure investment. But domestic savings also need to go into that sector. In that respect, Nepal needs to develop few instruments.

What could those instruments be?

For instance, you can allow banks to use some instruments to manage the mismatch between long-term lending and short-term borrowing. Here, reliable floating rate benchmarks would help, as it would enable banks to re-price, say, 15-year loan, every year. Individual banks have base rates and they are unique to each bank. Having a common benchmark, which is linked to, say, government bond yield will provide a level-playing field. So, both the users as well as banks can focus around the same benchmark. This will enable banks to raise deposit for a certain period by matching it with the benchmark rate. This will at least help manage the price risk, if not the liquidity risk. But for that to happen, you need to have a decent benchmark, and normally a government bond market is a starting point for that. As I understand, three-month treasury bills are auctioned regularly in Nepal, but there is no proper calendar for tenure bonds. And issuance of longer term treasury bills is infrequent. So, developing a deep government bond market with regular issuances and a proper primary dealer system, which actually facilitates secondary trading, will help establish these benchmarks. Once you have a government bond benchmark, it can be used to price credit for clients as well.

India, in fact, has a policy repo rate and most of the other rates fluctuate around this rate, which provides some certainty to investors. But Nepal doesn’t have such a benchmark. What is your take on this issue?

India is also moving ahead in stages and it still has a long way to go. So, I am sure these things will happen in Nepal as well. In fact, Nepal Rastra Bank (NRB) is taking right steps and is working towards deepening the capital market, especially the government bond market. At the moment, economic activities are muted in Nepal. That’s why we only hear about people buying houses and cars and not about investments in hydroelectric plants or roads. So, people still have not started talking about long-term investment here. Once economic activities start picking up, you will automatically start to feel the need for a well-functioning bond market. So, what Nepal is facing at the moment is a temporary situation. I had an opportunity to meet high-ranking officials of NRB recently and they are in touch with their peers in South Asia and are aware of what is required. I am sure they will put this infrastructure in place at the appropriate time.

But again, in Nepal, issuance of too much of government securities poses the threat of crowding out private investment. Are you aware of this fact as well?

I don’t see that threat at this stage. The banking sector is currently flush with liquidity and rates are extremely low. This is because the investment cycle has stalled. At this juncture, it won’t be a bad idea for the government to raise more money and channel those funds towards infrastructure projects. Normally, private investment is more efficient than public investment. But if the private sector is not making adequate investment, the government has to step in. This is happening in India. Currently, balance sheets of banks and corporate houses in India are under stress. So, adequate investment is not coming in from the private sector. At this stage, Indian government, despite running a fiscal deficit, is channelling lots of money towards development of roads, irrigation and railway projects. This is a welcome step because it will at least kick-start the investment cycle that has remained muted.

Let’s change the topic. You must be well aware of the directive issued by NRB, which has made it mandatory for commercial banks to raise minimum paid-up capital by four-fold to Rs eight billion within mid-July next year. What is your take on this issue?

NRB is our regulator and we respect and abide by whatever regulations it comes up with. Our capital adequacy ratio currently stands at 14 per cent, which is far higher than the requirement of Nepal and global standard setters. Once we raise the paid-up capital to Rs eight billion, our capital adequacy ratio will cross 25 per cent mark. This means we will have lots of capital, which needs to be converted into assets. Now, given the state of the real economy, where growth is slow, we don’t want additional capital going towards the financial sector rather than the real sector. Currently, the areas that are performing better are margin lending and real estate. Investment in these areas has lately doubled, whereas the country’s economic growth is expected to hover around 0.77 per cent in this fiscal year. This shows the growth of the financial sector and real economy is not in sync, which is not a very good sign. So, we don’t want banks to be tempted to chase the financial sector, rather than the real sector. These are some of the concerns that we have. But we’ve been in this country for 29 years and are the only international bank that has on-shore presence in Nepal, so we will find a solution. So, I repeat, we will comply with regulator’s requirement within deadline.

So, what is your capital replenishment plan?

We cannot discuss this with the media now. But we are holding discussions on the issue and will comply with the regulation within the deadline.

India’s inflation rate is one of the macroeconomic indicators that Nepal closely follows. This is because Nepal derives inflation from India. What is your outlook on India’s inflation?

Inflation now hovers around 5.39 per cent in India. It is very difficult to estimate how inflation will pan out over time because 46 per cent of goods and services in consumer basket comprises of food items. Food prices in sub-continent depend on monsoon, government’s procurement prices of grains, imports of food and supply chain management. At present, we expect a good monsoon. So, we are hoping food prices to remain under control this year. Considering this and on condition that oil prices remain where they are, we expect inflation to stand at an average of around 5.3 per cent this year. But Reserve Bank of India Governor Dr Raghuram Rajan is introducing credit policy on Tuesday, so he will tell us more on outlook for inflation.

Oil prices have gone up by around 80 per cent since January and at a recent OPEC meeting in Vienna, some of the ministers said the price will jump to around $55 to $65 per barrel in second half of 2016. Considering this, will India be able to maintain inflation at 5.3 per cent?

Standard Chartered’s view on oil prices is in line with the views of OPEC ministers. We expect oil prices to go up not because of robust global economic growth but because of supply-demand problem. For instance, the number of oil rigs in the US has dropped from a peak of around 1,600 in July 2014 to about 350. This clearly shows supply has started going down, in response to falling prices. On the contrary, despite possibilities of economic slowdown in China and even in India, demand for oil in these countries and even in the US has started growing. And we will see demand continuing to rise, which will drastically trim the current global oil surplus. So, we expect oil to head towards $60 a barrel and beyond by the end of the year. But this price will be manageable for Nepal and India because oil was trading at $110 a barrel three years ago. Having said that, what is also true is actual economic activities are still muted in India. Capacity utilisation currently hovers around 72 per cent and credit offtake is below 10 per cent. Also, there are stressed assets in both corporate and banking balance sheets and wholesale price inflation is still in the negative territory. Considering these, inflation should remain under control. Also, I think Dr Rajan has a huge amount of credibility as a good monetary policy and inflation manager. So, we expect inflation to remain under control.

There is no doubt about Raghuram Rajan’s credibility. But there are also rumours that he might not continue once his three-year term expires in September, and markets have started reacting to these talks. How are you observing these developments?

I think Dr Rajan has done a great job. Since the time he came on board, India’s macroeconomic indicators have improved. More importantly, he has given lot of strength to economy because of his reputation and the support he has garnered from the international community, with lots of people ranking him as one of the world’s best central bankers. Also, the market has endorsed what Dr Rajan has done, particularly the initiatives he took to clean up balance sheets of banks and manage foreign exchange and other external sector risks. These are the reasons why he has built a reputation of being a sound central banker amongst global investors. But what is also true is that the Indian economy, like the Nepali economy, is resilient. This means we can manage shocks and changes. And RBI as an institution is robust. It has stood the test of time; it is very independent; and lots of professionals work there.

One of the things that Rajan is credited for is cutting swings in the Indian currency by more than half since joining office. But rupee started losing weight soon after news about Rajan’s intention not to seek a second term started making rounds. What is your outlook on Indian rupee?

Lots of factors determine currency’s movements. First is global factors, such as Brexit — the June 23 voting in the UK on whether to remain in the European Union — the upcoming meeting of the Federal Open Market Committee, a committee within the US’s Federal Reserve System, China’s economic prospects, the US elections and politics in Europe. Also, domestic factors, such as repayment of around $26 billion under FCNR (Foreign Currency Non-Resident) scheme, determine currency’s movements. One of the ways Dr Rajan managed the currency swings was by bringing in huge amount of dollars using the FCNR scheme. Now, that money has to be repaid by the end of this year. RBI will manage that but the market will be apprehensive and there could be volatility. Also, India needs to settle the oil dues with Iran. So, these types of outflows also affect rupee’s valuation. But considering the growth differential between India and the US, and the fact that rupee is currently 13 per cent over valued on real effective exchange rate basis, a gentle depreciation of rupee is most likely.

So, you expect rupee to fall below all-time low of 68.85 against the US dollar recorded in August 2013?

I think it will because interest rates in India hover around 7.5 per cent, whereas interest rate in the US stands at 1.8 per cent. So, if I hold rupee I’m going to earn more interest. To that extent, rupee should depreciate. And I think it will depreciate by three to four per cent. This shouldn’t be a bad thing for India or Nepal as it will help us control imports and grow our exports, which will create employment opportunities in country.