The global economic situation continues to recover slowly and unevenly from the shocks of the COVID-19 pandemic and subsequent geopolitical tensions.
Many central banks are still maintaining their tight monetary policy stance to manage inflation.
The interconnectedness of global markets necessitates policy harmonization to mitigate the impact of global shocks on economic activity.
A strong domestic financial system and a robust institutional and policy framework are necessary to withstand external shocks, whether they stem from global financial crises, trade disruptions, or geopolitical tensions.
Undergoing Significant Reforms
Nepal’s financial sector has undergone significant reforms, particularly during three distinct phases.
The first phase of reform, initiated in the mid-1980s, focused on promoting institutions, liberalizing the banking sector, and enhancing the range of financial services offered.
To address debt distress and protect small and medium-scale enterprises due to higher interest rates, we introduced regulatory relaxations, loan rescheduling, and reclassification, among other measures.
The second phase of reform, starting in the early 2000s, concentrated on improving regulatory frameworks, strengthening financial stability, and enhancing the operational efficiency of financial institutions, especially the public sector banks.
Post-2010, the focus shifted toward financial consolidation. This period saw efforts to merge and consolidate financial institutions to create stronger entities, improving resilience in the system and contributing to sustainable economic growth.
Along with the financial reforms, the NRB has also embarked on a journey of significant operational reforms in monetary policy.
This operational reform has been gradual, with the introduction of the interest rate corridor in 2016/17 and a shift towards interest rate targeting from reserve targeting in 2020/21, aimed at enhancing the effectiveness of monetary policy transmission.
We also introduced new instruments, such as the Standing Deposit Facility (SDF) in 2023/24, for effective implementation of the IRC and effective liquidity management.
The recent policy reforms have concentrated on modernizing monetary policy operations, enhancing credit quality, emphasizing digital banking and FinTech, developing a modern payment system and its integration into the global market, and continuing financial consolidation measures.
Our focus is on better coordination between monetary and macroprudential policies.
The Nepal Rastra Bank (NRB) has been putting efforts into channeling credit toward productive sectors to ensure that the banking sector supports sustainable economic development and reduces the risk of asset bubbles.
We have also been promoting financial inclusion as a top priority, encouraging MSMEs, and enhancing access, literacy, and consumer protection measures related to financial services.
Despite a series of global and domestic shocks, such as the global financial crisis of 2008, the 2015 devastating earthquake, and the COVID-19 pandemic, Nepal’s financial system has shown resilience.
The growth momentum of more than 7 percent observed after the 2015 earthquake was halted by the COVID-19 pandemic and global supply shocks.
It contracted from the historical average of 4.5 percent to 1.9 percent in 2022/23.
The growth has now recovered to 3.9 percent in 2023/24.
Specifically, the construction, manufacturing, and trade sectors contracted during these two fiscal years.
Nepal also witnessed rising consumer price inflation at 8.6 percent in September 2022.
Due to timely policy interventions, weak internal demand, and some improvement in the supply side, inflation has now decreased to 3.6 percent in July 2024, with an annual average inflation of 5.4 percent in 2023/24, well below the target of 6.5 percent.
Nepal faced a rapid decline in foreign exchange reserves from late 2021 until 2022.
The NRB pursued a tighter monetary policy stance to prevent further reserve depletion.
The central bank maintained the higher interest rate policy regime for more than a year until May 2023, which has significantly improved the external sector and contained inflation.
Nepal’s financial system has also been overloaded with structural issues, including the poorly developed insurance and capital markets, especially the bond market.
To address debt distress and protect small and medium-scale enterprises due to higher interest rates, we introduced regulatory relaxations, loan rescheduling, and reclassification, among other measures.
At the same time, we continued reforms by introducing working capital guidelines for standardizing the credit need assessments of corporate sectors.
The external sector is in a relatively comfortable position, with a balance of payments and current account surplus, adequate FOREX reserves with an import capacity of 13.7 months in July 2024.
Interest rates have been declining, with the weighted average lending rate of commercial banks down to a single digit.
Some Challenges and the Way Forward for the Financial System
With the balancing measures, we have been able to safeguard overall macroeconomic stability.
Now, the key challenge is sluggish credit demand despite the lowered interest rates and adequate liquidity in the banking system.
By maintaining a balanced approach to monetary policy, enhancing regulatory frameworks, continuing reforms, and fostering financial inclusion, we aim to navigate the complexities of the financial landscape while ensuring sustainable and inclusive growth.
Moreover, the decline in credit expansion despite lower interest rates highlights the need for concerted efforts to stimulate domestic demand in the real sector and boost domestic economic activity.
Nepal is currently facing challenges in its economic landscape characterized by low growth, low savings, and low investment.
In this context, monetary policy is expected by other stakeholders to act beyond its mandate without considering its limitations.
Nepal’s financial system has also been overloaded with structural issues, including the poorly developed insurance and capital markets, especially the bond market.
Another emerging issue, due to technological advancement and fintech in the financial system, is strengthening cybersecurity and protecting against scams and data breaches in the context of ongoing financial digitalization.
We have made substantial progress in digital payments and settlements, but further work is needed to ensure consumer protection and safety.
Likewise, we are working on interoperability for domestic and cross-border payments and settlements.
We are also exploring new prospects like central bank digital currencies to cope with the digital era, enhancing inclusion and monetary transmission effectiveness.
To summarize, the path ahead involves addressing challenges while maximizing opportunities in the monetary and financial sectors.
By maintaining a balanced approach to monetary policy, enhancing regulatory frameworks, continuing reforms, and fostering financial inclusion, we aim to navigate the complexities of the financial landscape while ensuring sustainable and inclusive growth.
(The writer is the Governor of Nepal Rastra Bank (NRB), the central bank of the country)
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