Nepal | March 31, 2020

Finance and growth: Getting grasp of the link

Jagadish Prasad Bist & Aadersh Raj Joshi

The financial sector can work as a lubricant for the engine of growth. Since Nepal has ample investing opportunities, policymakers, government and concerned stakeholders need to put more emphasis on development of financial system

Illustration: Ratna Sagar Shrestha/THT

How finance is related to economic growth has long been debated by policymakers, bankers, academicians, researchers, entrepreneurs and other stakeholders. Extant research has shown that financial sector development is considered one of the key foundations on which sustained economic development can be built.

A well-functioning financial system is a must for economic growth, as it provides financial intermediation that boosts investment and transaction services which support firms and households, and also the tools to mitigate risk and guard against volatility at both the individual and national level. However, a recent research, particularly after the global financial crisis of 2008/09, has shown that higher level of development of the financial sector may not necessarily be beneficial for economic growth.

The crisis on the financial system, risk in the stock market and higher volatility of the credit default, particularly in the highly developed financial system, may indeed bring negative vibes in the growth process.

However, the importance of development of financial system on economic growth, especially in low-income countries (LICs) like Nepal, cannot be debated. As far as a healthy financial system is concerned, researchers have also agreed that LICs desperately need more robust and active financial system than that of the developed world. A healthy financial system indicates a high volume of financial transactions, a range of financial services access to firms and households of varying sizes and income levels and a higher level of banking sector efficiency where banking and financial institutions allocate credit to the most productive sector at the lowest cost possible. However, countries like Nepal are lacking in both policy formulation as well as implementation.

Weak regulatory bodies, corruptions and ineffective monitoring system could be some of the reasons for the sluggish development of the financial system in LICs like Nepal.

Nepal’s financial sector consists of banking and non-banking financial institutions, including NGOs, investment banks, mutual funds, insurance sector and the capital market. However, none of the sectors has shown a healthy and sustainable growth in recent years.

Nepal’s commercial banking industry, which holds more than 70 per cent of the total assets of the financial sector, has been facing prolonged issues of cartels, syndicate, credit frauds and accounting frauds.

Similarly, stock market is still in its nascent stage. It is yet to grow strong enough to help firms raise the required fund and invest it in the productive sector. Besides, prolonged political instability, the decade-long civil war, dearth of foreign technology and expertise, dismal foreign direct investment, lack of security and absence of credit and investment guarantees in mega-projects have further stifled the growth of the financial sector. As a result, Nepal’s financial sector has been confined to urban centres, and majority of the population living in villages or other parts of the country has little access to the financial services. This is why Nepal is witnessing poor growth of the private sector, underdeveloped entrepreneurship, high rate of unemployment, lack of access to fund and poor indicators of development index. Therefore, it is important to analyse whether the current financial system is healthy enough from both the structural and operational points of view.  And whether it is sufficient for the overall economic development of Nepal.

Finance Minister Yuba Raj Khatiwada in his white paper recently highlighted that the current financial system has not contributed much to economic growth of Nepal. The banking system in Nepal indeed has been losing confidence in private credit due to political instability. Hence, the contribution of the industrial sector to the gross domestic product has slumped.

A recent research on financial development and economic growth in LCIs, published on the Taylor and Francis Group’s Journal “Cogent Economics and Finance” shows that for the past 20 years, the flow of credit from banking institutions to the private sector is not significantly contributing to the GDP of Nepal. It is important to note that in the last 20 years the average flow of credit to the private sector as a percentage of the GDP is about 37.48 per cent. Although with this statistics, Nepal, among the LCIs, stands significantly at the top when it comes to growth of the banking sector, it is not sufficient to trace the pace of growth that developing countries are holding.

Nepal is striving to graduate from the league of Least Developed Countries to a developing country by 2022. Development of a healthy financial system is undoubtedly a prerequisite to achieve this target.

There is a need of higher credit flow towards the private sector.

Being an LCI, Nepal has ample investing opportunities. Therefore, policymakers, government, regulatory bodies and concerned stakeholders need to put more emphasis on the development of Nepali financial system.

The current economic policies of Nepal should be investment-friendly for domestic as well foreign investors. The foreign direct investment in all areas including the banking sector is the present-day need. Policymakers need to consider the financial sector as a lubricant for the engine of growth.

 


A version of this article appears in print on April 24, 2018 of The Himalayan Times.


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