monetary policy | interest rates | inflation | liquidity | refinancing

The NRB should come up with a tighter monetary policy

Why Nepal’s economy needs that

- By Karan Poudel |

Photo: Shutterstock
Photo: Shutterstock

The economic impacts of Covid-19 were so brutal, the Nepal Rastra Bank (NRB) had to adopt extra-loose monetary policies in the past two years in order to keep the economy’s engine running. Last fiscal year (which ended on July 15th) the central bank expected inflation to not overshoot the 6.5% target. Yet inflation breached that target last month, reaching 8.56%. That must be keeping central bankers awake at night.

During the pandemic, refinancing and subsidised loans facilities and low lending rates boosted the credit flow in the economy.  Targeted businesses, occupations and industries directly benefited from this. Demand for goods increased, as the economy began recovering. As a result, pressure on prices started building up at a time when supply chains were affected due to the temporary closure of factories around the world. 

The excess liquidity was especially good for the NEPSE Index. It reached 3198.60 on August 18th last year, making an all-time closing high. But now the index is down more than 35%. A combination of factors helps explain this: soaring inflation; rising costs of borrowings; and liquidity crunch.

Soon the NRB will unveil the monetary policy for the new fiscal year 2022-23. Carrying on the tradition, it has asked “opinions and suggestions” from the public for the policy. One thing that is important this time is that the central bank needs to be clear-headed enough to make sound decisions, as troubles facing the country are unlike any other in recent memory. 

In other words, the NRB would be wise to realise that Nepal’s economy needs a tighter monetary policy though what unfolds ahead is uncertain. It should immediately respond to the nightmarish economic data it has today. 

The stance of monetary policy should adjust as the situation evolves considering the need for monetary tightening to help curb rising inflation by slowing consumers’ demand and maintain financial and macroeconomic stability.

The rise in prices has become so persistent and inflation expectations of consumers so entrenched, they paint a black picture of the economy. In June edible oil prices rose 22.60%, furniture was 8.30% dearer and transport cost 25.79% higher. Employees’ wages and salaries climbed more than 8%, higher than the NRB’s 6.5% inflation target.

It is true that a few shortages, temporary factors and weak rupees have pushed up inflation. However, the central bank should not wait for those to ease, especially when the fate of the global economy is increasingly becoming uncertain. It is a foolish task, too.

The argument that Nepal being a net-importer of goods, it cannot achieve much when it comes to bringing stability to inflationary pressures holds true. But believing that to be completely true is misguided. Since consumers cannot borrow as much as they want, the possibility to contain inflation exists, at least to some extent. The higher the costs of borrowing, the lesser the demand for goods. So if raising the costs of servicing debt can slow the pace at which consumers’ demand grows, there is hope that inflation can be stopped from reaching painful levels. 

So why not raise interest rates? That will slash consumers' spending power, which will help subdue demand. And when some sort of equilibrium of supply and demand is reached, price pressures will likely fade away–though not fully. Interest rate increases will also help curb rising balance of payments imbalances, discourage lending to unproductive sectors and ensure stability in the financial system, especially when the stock market is pretty volatile. Monetary policymakers must give themselves enough flexibility to raise rates. The current situation demands not complacency but action.

Karan Poudel is an Investment Writer/Editor at Ansu Group. He was a former writer-analyst at the_farsight.

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