Finance Ministry and Nepal Rastra Bank split as economic crisis looms

At a time when the country’s economy is struggling with severe headwinds due to depleted foreign exchange reserves and a crippling liquidity crunch, the two main guardians of the national economy appear to be working at cross purposes. running.

There is little consistency between the approaches of the Ministry of Finance and the Nepal Rastra Bank to tackle the problem.

Long-standing political differences between these two economic decision-making bodies have resurfaced, with the central bank encouraging higher interest rates while the finance ministry aims to tame rates.

From September 17, most banks and financial institutions raised their interest rates, both for deposits and for credit, amid a shortage of loanable funds. This provoked a backlash from the private sector and Finance Minister Janardan Sharma backed them.

Inaugurating the NADA EV car exhibition last week, Minister Sharma said the development and expansion of the manufacturing industry had been hampered due to rising interest rates on loans, implying that the ministry of Finance could intervene in this matter.

He said he would take steps to address the high interest rate issue after consulting with stakeholders.

The Ministry of Finance formed a task force headed by its co-secretary Baburam Subedi on September 25 to recommend measures to be taken in response to concerns raised by the business community over high interest rates.

“It’s basically a fact-finding mission on the state of the economy,” Subedi said. “Based on research, we will recommend measures to address issues related to shortage of liquidity, high interest rates and foreign trade.”

The government’s concerns about high interest rates come at a time when the central bank is encouraging banks to raise interest rates, which would attract deposits, increase liquidity in the banking system by limiting credit expansion and would discourage imports.

After Covid-19, low interest rates have contributed to high imports of goods, leading to a sharp decline in foreign exchange reserves over the past fiscal year, raising fears that the country is heading for a crisis similar to the Sri Lanka.

Low interest rates not only fueled imports but also contributed to higher inflation by creating increased demand in the market. This after the Russian-Ukrainian war had already contributed to a rise in world prices.

Given this, the central bank introduced a tighter monetary policy in July to discourage credit growth and control inflation.

The two main objectives of monetary policy were to limit the expansion of credit to the private sector to 12.6%, a sharp reduction from the 19% targeted during the last fiscal year, and to limit the growth of the money supply. (cash, demand deposits, non-monetary assets that are highly liquid and easily convertible to cash) at 12% compared to last year’s target of 18%.

Private businesses have been protesting recent interest rate hikes by banks and financial institutions and have been mounting pressure on the government to remedy the situation. The Minister of Finance seems to have taken their concerns into account.

In a statement on Sept. 21, the Federation of Nepalese Chambers of Commerce and Industry (FNCCI) said interest rate hikes would put active businesses at risk and discourage new investment.

“It is also clear from past experience that raising interest rates alone would not bring deposits back into the banking system,” the private sector body said.

However, central bank officials say that given the state of foreign exchange reserves and still high imports, higher interest rates are needed to stabilize the economy.

“The economy faces the greatest threat from declining foreign exchange reserves,” said Prakash Kumar Shrestha, head of the economic research department at the central bank. “Even though imports have declined in the first two months of the current fiscal year compared to the same period of the previous fiscal year, the level of imports remains high and foreign exchange reserves continue to be under pressure.”

According to him, the country currently cannot pay import bills of more than 120 billion rupees per month, given the influx of funds, export earnings and tourism, foreign aid and foreign aid. foreign direct investment. But the country still imported goods worth Rs 273.59 billion in the first two months of the fiscal year, according to statistics from the Customs Department.

“We have to maintain relatively high interest rates to discourage imports and the country is also unable to reopen the import of motor vehicles,” Shrestha said.

The Cabinet had banned the import of several goods considered luxury items, including vehicles, in April, citing the massive collapse in foreign exchange reserves, and the ban was upheld by another Cabinet decision at the end of August .

While the central bank was opposed to the idea of ​​lowering interest rates and promoting imports, the government instead introduced a bloated budget with many populist measures targeting the elections.

The government has set a target of 8% economic growth, which will require a wave of loans. It is now exploring the option of lowering interest rates for companies, which is in direct opposition to the policy pursued by the central bank.

These political contrasts between the two sides are seen amid frosty relations between Finance Minister Sharma and Central Bank Governor Maha Prasad Adhikari. Sharma’s attempt to impeach Adhikari in April failed after the Supreme Court intervened.

Experts say political intervention is urgently needed to prevent the country from heading towards Sri Lanka, ensuring the country has adequate foreign exchange reserves.

Sri Lanka is facing its worst economic crisis and severe shortages of essentials like food, fuel and medicine due to a lack of foreign currency to pay for imports.

In the first month of the current FY 2022-23, Nepal’s gross foreign exchange reserves declined by 1.2% to $9.42 billion in mid-August 2022 from $9.54 billion dollars by mid-July 2022, according to the central bank.

“Given the current state of foreign exchange reserves and the balance of payments deficit, it is time to tighten our belts by controlling imports,” said former central bank governor Dipendra Bahadur Kshetry.

“Nor should the private sector expect cheaper loans like the ones they received after the Covid pandemic, which were intended to help hard-hit businesses. If loans are made available now at post-Covid interest rates, the economy will be heading for disaster.

He said the country must have sufficient foreign exchange reserves not only to support the import of essential goods and services, but also to attract and retain foreign investment in the country.

“Government and non-government sectors should take austerity measures to reduce imports,” he added.

However, former central bank chief executive Trilochan Pangeni said there was room for common ground with a selective hike in interest rates instead of a general hike across all sectors.

“It is necessary to keep interest rates low for the import of capital goods such as machinery, equipment and intermediate goods, as their imports contribute to economic growth,” he said, adding that the interest rates on the import of finished goods and other non-essential goods should be sharply increased.

Again, there is the flip side to consider. As the Post reported on Sept. 21, higher interest rates help fight inflation by raising the cost of borrowing, thereby encouraging individuals and businesses to borrow less and spend less.

Economist Keshav Acharya said higher interest rates would reduce private sector investment as profit margins narrow. “No one will invest if there is no return.”

The Asian Development Bank says GDP growth could slow amid tight monetary policy that would be needed to stem rising imports.

“Downside risks to growth may stem from tighter policy measures that may be needed to curb imports,” noted Arnaud Cauchois, Asian Development Bank country director for Nepal. This “will depress domestic production and consumption, negatively affecting growth.”

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