Nepal Rastra Bank, the central monetary authority, is mulling over introducing the Monetary Policy for the next fiscal year before July 16. The monetary instruments launched through the policy are crucial in maintaining price, fiscal and overall macroeconomic stability. Rupak D Sharma of The Himalayan Times talked to Shovan Dev Pant, CEO of Lumbini Bank, to learn more about expectations of the banking sector from the upcoming monetary policy.

Nepal Rastra Bank (NRB) is soon coming up with Monetary Policy. What kind of strategies is the banking sector expecting?

The NRB Act says one of the prime objectives of the central bank is to ensure price stability. So, one major area that the new monetary policy should focus on is inflation management. But historically, Nepal has not been able to manage inflation. Also, many people do not trust the data on consumer prices released by NRB. This is because official statistics do not correlate with price hike seen in the market. But again many things are not within NRB’s control. For instance, the size of Nepal’s informal economy, which, according to various studies, stands at around 30 to 40 per cent of the gross domestic product (GDP). This makes it difficult for NRB to contain inflation because money supply target and other monetary instruments do not work in an effective manner when the size of the informal economy is so big. Also, the existing trade pattern has played a role in rendering inflation management tools ineffective. Currently, over 60 per cent of Nepal’s imports come from India because Nepal has not been able to strengthen domestic production base. So, along with goods we are also importing inflation from India. Since there is nothing NRB can do to control price hike in India, the central bank has not been able to manage domestic inflation in an effective manner. But again even when inflation moderates in India, Nepal does not generally witness decline in prices. For instance, inflation currently hovers around 5.7 per cent in India, whereas the figure stands at 10 per cent in Nepal. This shows supply-side constraints are playing a big role in pushing prices up here. But again these things are not within NRB’s control.

Considering this, do you think the NRB will be able to meet inflation target of 7.5 per cent fixed by the fiscal policy?

As I said, many things are beyond NRB’s control when it comes to taming inflation. But what NRB can certainly do is introduce tools to keep real interest rate in positive territory. This can work as incentive for people to save. In a country like Nepal with huge infrastructure gap, policies should be framed to encourage people to save, as this helps in mobilising financial resources, which could be invested in productive sector. This ultimately helps in capital formation process. But to encourage people to save, real interest rates should be positive. However, in Nepal, depositors who park money in savings accounts get maximum annual return of four to five per cent. It’s even worse in bigger banks, where yields stand at around 1.5 to two per cent. Now consider these rates with inflation of 10 per cent and you’ll see that real interest rate is in a negative territory. Will such low rates encourage people to save? NRB has turned a blind eye to this problem for long. It is high time it conduct a thorough study and come up with tools to correct this.

But the problem here is that policy rate doesn’t work, isn’t it? That’s why rates are so low.

Yes, the policy rate isn’t working. The repo and reverse repo rates should move in certain tracks, which is not happening. So, there is no certainty on these rates. Also, there’s no certainty on inflation rate. Uncertainty in these areas will ultimately hit country’s sustainable economic development. So, savers have become losers in Nepal. This kind of culture is hurting salaried employees, who want to save whatever they can for the future. Unless this issue is addressed, people will keep on searching for avenues to generate quick returns, which can be risky, as it can drive up asset prices and create bubbles. Also, look at unemployment data of this country. As per official data, unemployment rate has stood at less than three per cent for the last one decade. If this data is accurate, then this country is not facing any problem at all. But the question is: does anyone believe in this figure?

But the issue with unemployment data is that it does not take economically inactive population into consideration, which stands at over 40 per cent. This means the data does not take into account people who don’t want a job, who are not looking for one or who cannot make themselves available even if they find work.

This means people who should be working are not working. Fortune.com, referring to the US government’s Central Intelligence Agency figure, says Nepal’s unemployment rate hovers around 50 per cent mark. I think this statistic is more accurate. Also, look at the quality of employment provided by the agriculture sector. This sector generates pseudo employment, with most of the people working for three to four months a year. Do you call this real employment? On top of all this, we are sending around 500,000 people abroad every year to work. Those are not jobs created by the country. But luckily the country has been surviving on money sent by Nepalis working abroad. In other words, remittance has become axis of survival for us. But as economies in the Gulf, where most of the Nepalis are working, have started facing slowdown due to low oil prices, Nepal is bound to face problems in the coming days. This issue should also be taken into consideration.

You mean to say fall in remittance income may have severe repercussions in the economy as this is the only source which has expanded foreign exchange reserve to almost 50 per cent of the GDP and helped balance of payments to remain in surplus?

Exactly. Many macroeconomic indicators are sound today because of remittance income. Banks are flush with money because of remittance. Indirectly, remittance has also helped the government to generate most of its revenue because remittance income is fuelling consumption, mostly imported. So, taxes levied on imports, including customs duty, value added tax and excise duty, are helping the government to boost its income. However, once remittance income starts declining, imports will fall, which will hit the government’s revenue. But again imports of certain imported goods, such as petroleum products, for which demand is generally inelastic, may not fall even if remittance income starts declining. So to import these goods, we need foreign currency. This will further deplete the stock in foreign exchange reserve, putting a strain on current account and balance of payments. So, NRB must devise strategies to cushion the impact of deceleration in remittance income and incorporate them in the upcoming monetary policy.

What other strategies or provisions should the upcoming monetary policy include?

Monetary policy of last year had a surprise element, as commercial banks were asked to raise paid-up capital by four-fold to Rs eight billion. So, many are curious if the central bank will create such a sensation this time as well. At the time when the provision on capital hike was announced, NRB had said the move was aimed at reducing the number of institutions through mergers. Later, NRB said the move was aimed at strengthening the financial health of banks and financial institutions. This was an indirect call for investors to inject fresh capital. So, the market is confused about objective of paid-up capital hike. But whatever the objective, banks will have to deal with certain consequences, as merger can sometimes be a painful process, while raising capital without opportunities for business expansion can hit profitability. If NRB’s real wish is to see investors injecting fresh capital, then banks have to grow their business by four-fold to continue distributing the dividend that they are currently extending. This may affect lending quality because the only sectors that seem to be growing at present are real estate and stock market, which are not productive.

Are you trying to say the decision to raise paid-up capital of commercial banks by four-fold will encourage banks to raise exposure to unproductive and risky sectors?

At present, only real estate and stocks seem to be doing well. Are these ripple effects of NRB’s decision to raise capital because banks are already under pressure to expand business, while credit demand from the real sector has not gone up? NRB must analyse this trend properly and come up with appropriate strategies to address these issues.

Credit demand from the real sector will not increase unless investment climate improves. But investment climate is not likely to improve anytime soon. Will this exert pressure on prices of banking stocks, which have soared in the recent days?

If banks fail to extend the present level of dividend after capital hike, investors will start raising questions. To prevent such a situation, banks may come under pressure to extend loans haphazardly. So, the possibility of banks extending double or triple the credit amount demanded by borrowers cannot be ruled out. This may ultimately create bubbles in the financial sector and hit asset quality of banks. Once banks’ balance sheets are under stress, share prices will come under pressure as well. So, NRB should be cautious about this and address this problem.

Lastly, the government has decided to raise Rs 111 billion in domestic loans in the next fiscal year. Since liquidity is still high in banking sector, NRB may raise statutory liquidity ratio (SLR) — or investment that banking institutions have to make in government securities. How would banks react to this move?

Raising SLR will not have much impact on banks because we already have to maintain liquidity-deposit (LD) ratio of 20 per cent. In fact, LD ratio of 20 per cent is the reason why banks have surplus liquidity. But, on the other hand, the stock of loanable fund is depleting. This is because funds allocated to maintain LD ratio cannot be extended to borrowers in the form of loans. Banks are now demanding that NRB give them greater access to loanable funds by relaxing the provision on credit to core capital-cum-deposit (CCD) ratio, which currently stands at 80 per cent. But again whether CCD ratio should be increased is a debatable issue.

What is your personal opinion on this issue?

Well, increasing the CCD ratio can raise profitability of banks. But again this may come at the cost of safety of banks and their ability to cushion shocks. My personal view on this issue is that banks are generating good profit. Even banks that are said to be generating moderate profit are extending 12 to 15 per cent return on equity. Few are extending 60 to 70 per cent return on equity. No bank in the world extends 60 to 70 per cent return. So, I am not very much in favour of the argument that NRB should raise CCD ratio to further increase profitability of banks. Instead, more focus should be laid on creating an enabling environment for growth of the real sector, so that real credit demand could be created. Also, focus should be laid on changing provisions on deprived sector lending, under which commercial banks have to extend loans equivalent to 4.5 per cent of credit portfolio to deprived sector. This provision has only benefited microfinance institutions rather than end borrowers, because credit extended by us to microfinance institutions at four per cent interest are being extended to consumers at interest of as high as 20 per cent or more. So, the benefit of cheap credit extended by us has not trickled down to borrowers.

*Corrections made on June 29, 2016.