The Ongoing Liquidity Crisis and the Nepalese Economy: Reasons and Measures

Nepal has been grappling with a severe liquidity crisis over the past few months, raising concerns across the nation. Various stakeholders attribute this crisis to different factors. Many blame the banking sector for its reckless lending practices, which saw a 30% growth in loans within the first four months of the current fiscal year, far outpacing the 19% growth in deposits. Conversely, bankers and some economists argue that the crisis stems from delays in government capital expenditure. Others point to the Nepal Rastra Bank’s (NRB) recent monetary policy, which restricts banks from leveraging their capital, reserves, debentures, and new provisions for further market investments.

Current Status of the Nepalese Economy

In the first four months of the ongoing fiscal year, government capital expenditure reached only 6% of the budget, a sharp decline from the 10% recorded in previous years. Remittance inflows, a lifeline for the economy, have declined by 11% compared to the previous year—the first downward trend in years. While exports surged to Rs. 100 billion, imports skyrocketed to over Rs. 6.5 trillion during the same period. This has led to a negative balance of payments (BoP) exceeding Rs. 1.5 trillion, a rare occurrence in recent history. Foreign currency reserves have dwindled to Rs. 11 trillion, sufficient to cover only seven months of imports—a reduction of nearly Rs. 3 trillion from Rs. 15 trillion at the end of Ashadh 2078, when reserves could sustain 11 months of imports.

The country is still recovering from the prolonged impact of the COVID-19 pandemic, which devastated key sectors such as tourism, transportation, hotels, and travel—major contributors to Nepal’s gross domestic product (GDP). These industries are only beginning to revive, but the emergence of the Omicron variant poses a renewed threat. Additionally, unseasonal post-monsoon rainfall, floods, and natural calamities have hampered agricultural production, further straining GDP contributions. With millions of job seekers awaiting opportunities abroad and remittance income falling short of expectations, Nepal’s economic outlook remains bleak.

Nepal’s Import-Dependent Economy

Despite being an agricultural nation, Nepal relies heavily on imports, even for basic food grains from India. Vast tracts of arable land lie barren while millions of Nepalese migrate to the Middle East, enduring harsh conditions to earn a living. A country that exported paddy and wheat 30–35 years ago now imports substantial quantities to feed its population.

In the first four months of this fiscal year, imports exceeded Rs. 6.5 trillion, while foreign reserves dropped from covering 11 months of imports during the pandemic to just seven months now. Even with import restrictions, the situation is dire. Exports, though doubled to Rs. 100 billion compared to the previous year, offer little relief. Much of this growth involves minimal value addition (10–15%), with branding, packaging, and labeling dominating exports like palm oil, ghee, and wires under SAFTA benefits to India. Exceptions include handicrafts, tea, coffee, and ginger, but high-value imports like petroleum, steel, and vehicles drain reserves without contributing to GDP.

Employment, Production, Consumption, and Savings

Nepal is not an industrial powerhouse. Over 70% of its population depends on agriculture, yet this sector contributes less than 35% to GDP. Remittances, a key income source for households, are declining for the first time in years. The service sector drives the highest GDP value, while manufacturing accounts for less than 20%. Post-COVID, thousands of overseas workers returned, and domestic laborers await factory recalls. With limited manufacturing units and a shortage of skilled workers, Nepal relies heavily on Indian labor. New ventures, startups, and employment-generating activities remain stalled due to financial losses from the pandemic and ongoing uncertainty.

Household savings are below 10%, with most remittance income spent on consumables or non-productive sectors. The government has yet to formulate policies channeling remittances into productive investments like industry or manufacturing, exacerbating the lack of retained funds within the country.

The Liquidity Crisis

The NRB has flagged the banking sector’s excessive loan growth—50% of the full-year target achieved in just four months. Deposits grew by only Rs. 20 billion, while lending surged beyond Rs. 3.5 trillion. Government capital expenditure remains dismal at 6%, though Rs. 60–70 billion in private-sector taxes is expected to flow into government accounts soon. With remittances falling, imports soaring, and BoP and current account balances deteriorating, the NRB has tightened policies. The revised credit-to-deposit (CD) ratio and credit period restrictions have disqualified Rs. 4.5 trillion in investable funds, pushing banks—many already exceeding the 90% CD ratio—into an acute liquidity shortage. Interest rates have climbed to 10.05%, despite NRB’s efforts to keep them below double digits.

The stock market, which peaked above 3,200 points during the pandemic, has plummeted to 2,400 in two months, losing 100 basis points weekly. Investors blame NRB restrictions, the economic crisis, and government inaction, with protests targeting the NRB Governor and political leaders growing louder.

Root Causes of the Crisis

Nepal has not faced such a severe economic downturn during the 2008 global financial crisis, the Nepal-India border dispute, or even the peak of COVID-19. The banking sector’s CD ratio exceeds 91%, while capital adequacy ratios barely sustain existing operations. So, what triggered this sudden crisis? Key reasons include:

1. COVID-19 Fallout: The pandemic’s economic impact is now fully evident.
2. Massive Imports: Rs. 6.5 trillion in four months, compared to Rs. 10 trillion for the entire FY 2077/78.
3. Remittance Decline: An 11% drop as skilled migrants retain earnings abroad or invest in stocks, property, or cryptocurrencies.
4. Low Capital Expenditure: Only 6% of the budget spent, despite strong tax collection.
5. Excessive Lending: Banks expanded loans by 30% in four months, half the annual target.
6. Consumer Behavior: A culture of consumption and show-off lifestyles overshadows savings and productive investment.
7. NRB Policies: Stricter CD and CCD ratios have curtailed lending capacity.
8. Private Sector Practices: Speculative and profit-driven traders and industries exacerbate the crisis.

Future Outlook and Risks

The Omicron variant threatens further lockdowns, which could deepen the crisis. Nepal’s heavy reliance on external employment, income, production, and consumption leaves it vulnerable. BoP and current account deficits will likely worsen, pushing the NRB and government toward stricter regulations. Without curbing imports or boosting exports and remittances, the country risks a Sri Lanka-like scenario, where banks’ letters of credit (LCs) or import documents could be rejected, forcing advance payments or defaults on external loans.

Proposed Measures

To mitigate this crisis, short-term solutions are critical:

• Restrict Non-Essential Imports: Prioritize only vital goods.
• Limit Foreign Travel: Conserve foreign exchange reserves.
• Promote Electricity Use: Encourage electric transportation, cooking, and industrial applications to reduce petroleum imports.
• Utilize Local Resources: Boost domestic production, e.g., clinker for cement.
• Accelerate Government Spending: Release funds swiftly to stimulate the economy.
• Channel Public Funds: Allow state/provincial government deposits in banks to count as lendable funds for priority sectors like infrastructure, agriculture, and tourism.
• Ease Foreign Borrowing: Permit banks to borrow abroad and seek long-term loans from foreign donors.
• Attract Investment: Simplify policies for Non-Resident Nepalese (NRN) investments and foreign direct investment (FDI).

These measures must be implemented immediately to avert a deeper crisis.

Thank you,

2021-12-11( 17:33)