Liquidity crisis and low capital spending

For about a month now, two reports on the Nepalese economy, the liquidity crisis (limited availability of loanable funds in the banking sector) and low government capital spending have dominated the media. The latest data released by Nepal Rastra Bank, the central monetary authority, also indicates a serious shortage of liquidity in the market. During the first two months of the current fiscal year, the central bank injected a net amount of Rs362.5 billion into the financial market, of which Rs352.3 billion came from the bank’s permanent liquidity facility. In mid-September, deposits in banks and financial institutions (IBFs) increased by only 0.7% to almost 4.7 trillion rupees, while credit disbursements increased by 5.7%. %. The liquidity currently available in the system is estimated at only around Rs.55 billion, which also benefits a few financially healthy banks.

One of the reasons for liquidity volatility in the market is the excessive dependence of CIBs on institutional deposits as opposed to individual retail deposits. For years, the share of institutional deposits in CIBs, mainly coming from two pension funds and the insurance sector, has remained consistently above 40%. This share of deposits suddenly fell 2.7 percentage points from 43.2 to 40.5%, which in nominal terms means around Rs 130 billion out of the banking system. The other two key factors that have hit liquidity so hard are the reduction in workers’ remittances and a geometric increase in imports.

The net inflow of remittances declined 6.4% to 172 billion rupees in the first two months of the fiscal year, resulting in a commensurate decrease in the foreign exchange reserve. According to Customs Department data for the first three months of the current fiscal year (as of October 15), the amount spent on imports by the country amounted to Rs 478.5 billion compared to Rs 65 billion from foreign sources. exports. These data do not include many informal imports from markets across the open border with India. As a result, the cost of funds has actually increased to 15 percent.

Low capital expenditure

The low level of capital expenditure has been a chronic problem in the Nepalese economy, which is considered to be the most crucial reason for the recurring liquidity crisis in the banking sector. For example, in fiscal year 2020-2021, total capital expenditure was barely 50% of the capital budget. According to the Economic Survey 2020-21, this spending in the previous fiscal year, 2019-20, was only 46.2%, while aggregate capital spending at the federal, state and local levels was even higher. low, at 34.1%.

In the first 110 days of the current fiscal year, in November 2021, capital spending stood at a paltry 4.53% of the allocation of Rs 440 billion. This means that the Treasury has only released about Rs20 billion against an expected average of over Rs100-125 billion in the first quarter. This is the amount that appears to be running short in the money market to make business run as usual and keep the interest rate from climbing double digits.

There are several long-standing structural issues surrounding the weak absorption capacity of the development budget, including Nepal’s budgeting practices, rapid disbursement of funds, and efficiency of project spending. On top of that, the government failed to enact the regulations needed to facilitate development spending once it replaced the budget ordinance introduced by the previous KP Sharma Oli government with a budget bill. which was ratified after causing an interruption of the “budget holiday”.

Institutional inefficiency

The institutional inefficiency of the two main public institutions responsible for managing the country’s economy, the Ministry of Finance and the Nepal Rastra Bank, is at the center of repeated systemic restrictions that are becoming increasingly costly for the economy. Ironically, these two institutions are now run by non-economists who try to run the show only with their basic common sense and learning-by-doing experience. This too might have been manageable under normal circumstances. Yet it is an extraordinary time for the economy trying to readjust with the putative new post-Covid-19 normalcy coupled with dramatic political transitions, both at the federal and provincial levels.

Finance Minister Janardan Sharma’s complete lack of basic economics knowledge and insensitivity to addressing current issues such as liquidity crunch, low capital spending and growing trade deficit are now the focus open debate in bureaucratic and donor circles. Instead, his keen interest in spotting possible mining holes in the system to raise funds for “political finance” is the modus operandi noticed. His use of muscle to alter the laws and practices of public procurement is proof of this.

Likewise, the failure of the central bank, both in monetary management and in regulatory oversight of the financial system, has compounded the injuries. Although successive monetary policies have allowed Nepalese banks to source loans from international CIBs when the system experiences such a fund crisis, the policy has had very limited success. This is attributed to the very low credibility of the Nepalese financial system, which is still off the international (sovereign) rating radar and reported cases of regulatory arbitrage are rampant. This blame falls squarely on the shoulders of the regulator of the monetary system, the central bank.

The bank also seems powerless to discipline CIBs to immediately set their interest rates inversely proportional to their profit margins and eliminate inequalities in pay and benefits between their employees and managers. This is paradoxical because CIBs continue to make high profits but are unwilling to reduce the interest rate on loans. Senior CIB executives are allowed to gobble up salaries and benefits that are up to 25 to 30 times higher than their lower level colleagues. This is clearly a regulatory failure.

In the immediate term, the government must find ways to substantially increase capital spending which, in turn, will automatically compensate for the current crisis in loanable funds. Nevertheless, the importance of political and institutional reforms in the medium and long term should not be underestimated.

About Alexander Estrada

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