REVIEW ON MONETARY POLICY FOR THE FISCAL …surajtamang.com.np/.../REVIEW-ON-MONETARY-POLIC… · Web viewWhile, Remittance collected lots of revenue on country and played pivotal

SUBMITTED BY:

AMBIKA LAMICHHANE

MANDIRA RIJAL

RUMA KARNA

SHARA GHIMIRE

SURAJ KUMAR TAMANG

MBA 2nd TRIMESTER

SECTION: HIMALAYA

SUBMITTED TO:

MR. SANTOSH ACHARYA

LECTURER OF ECONOMICS

APEX COLLEGE

KATHMANDU, NEPAL

2018

REVIEW ON MONETARY POLICY FOR THE FISCAL YEAR 2062/63-2064/65

ACKNOWLEDGEMENT

Our efforts on this report would not have been possible without the kind support and help of many individuals. We would like to extend our sincere thanks to all of them.

We are highly indebted to Mr. Santosh Acharya, Lecturer of Economics, for giving us this wonderful opportunity to learn about one of the most important aspects of the Nepali economy. We are also thankful to him for his guidance and constant supervision as well as for providing necessary information regarding the project.

Our thanks and appreciations also go to our friends in pushing us constantly for developing the project and for helping us out in their best possible ways.

Special mention also goes to our family for their kind co-operation and encouragement which helped us in completion of this project.

We would like to extend thanks to the many people who so generously contributed to the work presented in this review with various sorts of ideas and knowledge.

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1.1.1 GROUP PHOTOS

Photo 1 : Group Members with Mr. Santosh Acharya, Lecturer of Economics

Photo 2 : Group Members Discussing on the Topic

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ContentsACKNOWLEDGEMENT.........................................................................................................ii

GROUP PHOTOS....................................................................................................................iii

LIST OF ABBREVIATIONS....................................................................................................v

CHAPTER I: INTRODUCTION...............................................................................................1

1.1 BACKGROUND OF MONETARY POLICY- FY 2062/63..........................................1

1.1.1 OBJECTIVES OF THE FY 2062/63...................................................................3

1.2 BACKGROUND OF MONETARY POLICY- FY 2063/64..........................................3

1.2.1 OBJECTIVES OF THE FY 2063/64...................................................................5

1.3 BACKGROUND OF MONETARY POLICY-FY 2064/65...........................................5

1.3.1 OBJECTIVES OF THE FY 2064/65....................................................................7

CHAPTER II: PRIMARY FUNCTION OF MONETARY POLICY.......................................8

2.1 MONETARY INSTRUMENTS......................................................................................8

2.2 BANKING REGULATIONS.........................................................................................14

2.3 LIQUIDUTY MANAGEMENT....................................................................................17

2.4 EXCHANGE RATE/FOREIGN EXCHANGE RESERVE..........................................19

2.5 MONEY SUPPLY..........................................................................................................23

2.6 INFLATION...................................................................................................................26

CHAPTER III: DEVELOPMENTAL FUNCTION OF MONETARY POLICY...................30

3.1 FINANCIAL ADVISOR OF GOVERNMENT.............................................................30

3.2 PROMOTING INVESTMENT TO PRIVATE SECTOR.............................................31

3.2 PROMOTE/CONTROL CONSUMPTIONS.................................................................32

3.3 SUPPORTING ECONOMIC GROWTH.......................................................................34

3.4 TRADE PROMOTION..................................................................................................35

3.5 OBLIGATORY INVESTMENT PORTFOLIO TO BFIS.............................................36

3.6 POLICIES TO MAINTAINING FINANCIAL STABILITY (INTERNAL AND EXTERNAL)........................................................................................................................38

CHAPTER - IV: GROUP REMARK......................................................................................40

4.1 GROUP REMARK ON MONETARY FUNCTION.....................................................40

4.2 GROUP REMARK ON DEVELOPMENT FUNCTION..............................................40

REFERENCES………….....................................................…………………………………42

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LIST OF ABBREVIATIONS

AD Aggregate Demand

ADB/N Agriculture Development Bank of Nepal

AIG Accord Implementation Group

AMC Assets Management Corporation

BCP BASEL Core Principles

BFIO Bank and Financial Institutions Ordinance

BFIs Bank and Financial Institutions

BIS Bank for International Settlement

BOP Balance of Payments

CAD Cash Against Document

CAR Capital Adequacy Ratio

CBOs Community Based Organizations

CPI Consumer Price Index

CRR Compulsory Reserve Ratio

CSCs Citizen Saving Certificates

DRT Debt Recovery Tribunal

GDP Gross Domestic Product

HMG His Majesty Government

M1 Narrow Money

M2 Broad Money

NBFI Non-bank Financial Institution

NBL Nepal Bank Limited

NDA Net Domestic Assets

NEPSE Nepal Stock Exchange

NFA Net Foreign Assets

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NPL Non Performing Loan

NRB Nepal Rastra Bank

NSCs National Saving Certificates

OMOs Open Market Operations

RBB Rastriya Banijya Bank

RDB Rural Development Banks

REER Real Effective Exchange Rate

RETs Renewable Energy Technologies

RM Reserve Money

RMDC Rural Microfinance Development Centre

RNAC Royal Nepal Airline Corporation

RSRF Rural Self-Reliance Fund

RWA Risk Weighted Assets

SLF Standing Liquidity Facility

STI Second-tier Institution

VAT Value Added Tax

VRS Voluntary Retirement Scheme

WRDB Western Rural Development Bank

WTO World Trade Organization

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CHAPTER I: INTRODUCTION

Monetary policy is the macroeconomic policy laid down by the central bank primarily to manage aggregate demand. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity. Like other policies, the primary objectives of monetary policy to attain the macroeconomic goal or objectives such as stability, growth, full employment, favorable balance of payment and so on. Johnson defines monetary policy “as policy employing central bank’s control of the supply of money as an instrument for achieving the objectives of general economic policy.” G.K. Shaw defines it as “any conscious action undertaken by the monetary authorities to change the quantity, availability or cost of money.”

The initiation of monetary policy in Nepal dates back to 1960s. Since then, Nepal Rastra Bank (NRB) has been introducing various forms of monetary policies and strategies. NRB Act 2058 paved the way to formulate sound comprehensive monetary policy and strategies by Nepal Rastra Bank. Consequently, NRB has introduced monetary policies since the fiscal year 2059/60. Due to the implementation and favorable impact of such monetary policies and strategies, progress has been witnessed on the process of financial deepening in the economy. Before liberalization, Nepal Rastra Bank followed direct monetary instruments such as interest rate, margin rate, statutory reserve requirements (SLR), and so on. However, after economic liberalization, indirect instruments such as cash reserve ratio, open market operation and bank rate have been used. These instruments first affect the aggregate demand and thereby it affects real sector variables such as price level, income, employment, output, and so on. But in Nepalese case, like other policies, monetary policy has not been effective to achieve its goals or objectives because price level is not explained by money supply alone. This report has made with an attempt to overview the impact of monetary policy in terms of some macroeconomic indicators such as price level, economic growth, balance of payment and equity.

1.1 BACKGROUND OF MONETARY POLICY- FY 2062/63

Nepal has established Five Year Plan from a long time and 2062/63 is the 4th year of 10th Five Year Plan starting from 2059/60-2063/64. Governor was Mr. Bijaya Nath Bhattarai who continued his term of office from January 2005 to July 2007. GDP at Producers price for the First three year of the plan was 3.1%, but the rate has decreased to 2.7% in the year. Country has expected to increase it GDP at producer’s price by 6.0% and attend 10.8% on average by the end of the current Five Year plan. The decline in agriculture production due to mainly unfavorable weather conditions and significant slowdown in non-agriculture caused decrease in the rate. Growth rate of non-agriculture sector declined from 3.5% to 1.6 % in FY

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2061/62. The existing difficult law and order situation has been the principle cause of lower economic growth in the country. The difficult security situation has adversely affected the capital spending which registered a negative growth of 2.4 % in FY 2061/62. The import export part of the country was unsatisfactory. The export of woolen carpet decreased marginally by 0.3 % in the first eleven months of FY 2004/05 while the export of readymade garments declined substantially. The rise in VAT to 13 % from 10 % have all generated a pressure on the general level of prices. Increase in oil prices during the year had brought good VAT revenues. The sad part was declination of Net Foreign Exchange and low contribution from Tourism Sector. While, Remittance collected lots of revenue on country and played pivotal role in bringing light to success. On April 23, 2004, Nepal obtained the membership of World Trade Organization (WTO) on April 23, 2004. However, the abolition of quota system for garment export since January 1, 2005 under the provision of WTO has adversely affected Nepal’s export of readymade garments.

NRB has impacted majorly on the Foreign Exchange and in maintaining real effective exchange rate (REER) at an appropriate level to maintain the monetary stability. The pursuance of liberal economic policy has resulted in the remarkable development of the financial sector in the last two decades. However, banking sector, a dominant component of the financial sector, has not witnessed a qualitative development to the desired extent. In the light of this fact, the monetary policy instruments such as gradual phasing out of priority sector credit program, the cut in compulsory reserve ratio (CRR) and the bank rate, provision of concessional refinance facility and conduct of transparent open market operations (OMOs) have been initiated for the last couple of years. The report prepared by NRB measures undertaken with respect to foreign exchange reserve management, reforms in external sector; and the status of the regulation, inspection and supervision of the financial sector.

Slowdown in BOP cannot be corrected only via monetary policy. Fiscal year policy and exchange rate policy is also important. The share of Nepal’s total trade with India increased to 65.0 % in FY 2061/62 from 54.7 % in FY 2059/60. In order to manage the reserves of Indian currency and at the same time to enhance the competitiveness of Nepali industries, the number of goods to be imported from India against the payment of US dollars had increased. While the present situation of sluggish economic activities and some problems faced by the financial sector call for a softer monetary policy stance, prevailing situation of the pressure on prices and weak external sector on the other hand, warrant a tighter monetary policy stance.

During the period Nepal turned into a liberal and market friendly economy. Nepal committed to allow the operation of branches of foreign banks which strengthen the capacity of banks and financial institutions. To achieve these objectives, the NRB in FY 2062/63 is undertaking various financial sector reforms programs. As a result Nepal was able to welcome foreign banks. The primary responsibility the Bank is to maintain financial sector stability for which banks started the licensing policy of financial institutions, inspection and supervision based on basic Nepal Rastra Bank prudential Bank for International Settlement (BIS) principles, compliance of corporate good governance, legal reforms in the financial sector, liberalization and structural reforms to the international standards. With a view to develop the NRB into a

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modern central bank, it stared updating the information technology, supervisory capability, human resource management and international accounting standard and Nepal accounting standard.

The development of industries and commerce requires increased production and productivity by means of investment friendly environment. Nepali banks are experiencing growing complexities in credit recovery and payments settlement for the last few years. Following the policy of financial sector liberalization in the past two decades or so, a large number of financial institutions have come into operation. Merging of a bank and non-bank financial institution (NBFI) with another one, or a bank and NBFI acquiring others into itself, is a natural and an inevitable consequence of a soundly functioning financial system. To redress and settle the grievances that result from the misunderstandings between banks, financial institutions and customers, a grievance-hearing cell (GHC) has already been constituted in the central office of this Bank under the chair of the Deputy Governor. In the context of promulgation of the BFIO 2062, the existing regulations and directions, which were separately issued for banks and financial institutions, have already been revised and integrated into a single directive. The capital adequacy ratio (CAR) to be maintained by bank and financial institutions (BFIs) was set at 12 % of their total risk weighted assets.

The public statement of income and expenditure for FY 2062/63, has made the provision to exempt the income tax on the interest income earned from the deposits amount of up to ten thousands rupees held in the rural microfinance institutions. As this step of HMG will be very helpful for the small depositors and microfinance institutions, the NRB has taken this endeavor very positively.

1.1.2 OBJECTIVES OF THE FY 2062/63

The objectives of the Monetary Policy are:

To maintain price stability. To remove any sorts of disturbances to the normal functioning of the economy. To maintain a reasonable level of surplus in the BOP which is projected at Rs. 4.5

billion for FY 2062/63. To maintain the foreign exchange reserve at the comfortable level To support a high and sustainable economic growth in through the promotion of the

private sector

1.2 BACKGROUND OF MONETARY POLICY- FY 2063/64

The overall economic growth rate for that year was targeted at 4.5 %. It has been the tradition of the bank to formulate independently the monetary policy ensuring the consistency with

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Government Statement. The Governor was Mr. Bijaya Nath Bhattarai. The economic growth was projected in the range of 4-4.5 % for 2062/63 in the monetary policy statement. Such an estimate of economic growth was based on the expectation of normal weather condition leading to good harvest and settlement of political issues resulting in resumption of peace in the country would generate positive impact on the non-agricultural sector. The Nepalese economy was also expected to benefit from the high economic growth in the world as well as in the neighboring countries. The Central Bureau of Statistics (CBS) had recently published the preliminary estimate of growth of gross domestic product (GDP) at factor cost to be 2.3 % in 2062/63. The CBS's estimate of GDP growth rate at producers' price for 2062/63 is at 1.9 %.

The growth of overall food grains production remained negative due to the fall in production of the major food crops such as rice, wheat and barley. As a result, the overall agricultural production grew just by 1.7% which was the lowest agricultural growth rate in the last eight years. The growth rate of the non-agricultural sector, too, remained unsatisfactory in 2062/63 due to unfavorable investment environment in the economy. Despite the four months long ceasefire declared by the rebels, peace talks remained elusive, political stalemate also continued. This scenario deteriorated investment climate. Consequently, this sector grew by just 2.8%. The analysis of the national output from demand side shows that aggregate domestic absorption increased in FY 2062/63 compared to the previous year. Of the aggregate domestic demand, total consumption expenditure increased, while the growth of total fixed capital expenditure remained low. A rise in private sector consumption resulting from a remarkable increase in remittance inflows as well as higher recurrent expenditure of the government accounted for such an increase in aggregate consumption expenditure.

The trend of the negative growth of net external demand for Nepalese goods and services continued in the review year. A higher growth rate of imports relative to the exports, negative net services income since the last two years and consequently increase in the magnitude of net negative inflows were the factors responsible for such a high negative growth of net demand for Nepalese goods and services.. Because of various ups and downs, external demand for Nepalese goods and services plays a crucial role in stimulating economic growth. Therefore, a strategy of structural change in the composition of domestic absorption and high export of goods and services should be pursued to attain high economic growth in the country.

Monetary aggregates are expected to expand at a higher rate than the projections made in the annual monetary policy of 2062/63. In the first ten months of 2062/63, broad money supply increased by 10.8 % and is estimated to expand by 16.3 % by the end of 2062/63 as against the projected growth of 13.0 %, due mainly to the higher than estimated growth of workers' remittances. In 2062/63, lack of investment friendly environment and cautious approach taken by commercial banks in lending have resulted in a lower growth of bank credit extension to the private sector than initially estimated.

The International Monetary Fund (IMF), in its World Economic Outlook released in April 2006, has stated that the world output has increased significantly since 2004. The IMF has

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projected the world output to grow by 4.9 % in 2006 and 4.7 % in 2007. The IMF's study has stated that inflation remained in check because of global excess production capacity after the Asian crisis of 1997/98, control on wages and prices emanating from an increase in competition in international level due to globalization and increase in productivity. World inflation remained in check on account of reversal of accommodative stance of monetary policy and adoption of the policy of hiking interest rates in the wake of narrowing of world output gap and increasing inflationary expectations at the backdrop of persistent rise in oil prices.

Since Nepal is a small and open economy, the impact of world economic development has been felt on the economy, both directly and indirectly. Nepal could not benefit from high growth of global output in terms of growth of GDP because of internal conflict and political stalemate. However, consequent to higher growth in global output, the demand for Nepalese labor in the regional labor market is increasing. As a result of this, the inflow of workers' remittances has increased significantly. This has helped in maintaining external sector stability even in the conflict situation. The growth in world output will be at risk if such an imbalance is not resolved properly. This could ultimately affect and put at risk the demand for Nepalese laborers in the international labor market, export of goods and services from Nepal, and foreign assistance that Nepal expects to receive from the world community in the present context.

Nepal's inflation outlook for 2063/64 would rest on the level of increase in international oil price and the policy level decisions that would be taken to address the accumulated loss of NOC which stands at Rs.11.0 billion. The spare capacity of world output has recently decreased. As the high economic growth rate in India, China and Russia has exerted pressure on the price of construction materials, world inflation is likely to rise. As the central banks of the world have adopted tight stance of monetary policy, the impact of such a stance on world inflation will also affect inflation in Nepal.



To present perception of this bank on macroeconomic situation by analyzing the monetary, financial and economic sectors,

To explain to the public about monetary policy measures implemented in the previous year and policy measures initiated for the current year,

To undertake monetary management based on the projection of economic and monetary situation.

To maintain price stability, external sector stability, financial sector stability, To facilitate a high and sustainable economic growth.

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1.3 BACKGROUND OF MONETARY POLICY-FY 2064/65

Following the provision in Nepal Rastra Bank (NRB) Act 2002, the NRB has formulated and implemented five annual monetary policies so far. The Governor was Mr. Krishna Bahadur Manandhar who continued his tenure from July 2007 to January 2009. A review of the monetary policies of the last five years shows that consumer price based average annual inflation, which is the primary objective of the monetary policy, remained at 5.5 %. Although the international oil price and the prices of the domestic food items increased, inflation was contained in the last five years on account of the pegged exchange rate regime with Indian currency, low budget deficit and liquidity management through open market operations (OMOs). External sector also remained stable in the last five years. The year before the bank started announcing annual monetary policy, the balance of payments (BOP) was in deficit. However, the BOP remained at surplus of about Rs 12 billion on an average in the last five years. Although the performance of the exports of goods and services remained less than satisfactory, the inward remittances of the Nepalese workers working abroad contributed to the stability of the external sector.

Economic growth did not remain satisfactory in the last five years, however. Real gross domestic product (GDP) at factor cost grew by 3.3 % on an average during that period. This five year’s period also coincided with the Tenth Plan period. The Tenth Plan had targeted the average economic growth of 4.3 % under normal condition and 6.2 % under improved scenario during the plan period. The low economic growth was due to the low investment on account of internal conflict and political instability.

A number of banks and financial institutions licensed by the bank went up significantly during the last five years, from 151 in mid-July 2002 to 208 in mid July 2007. Of the financial institutions, the number of development banks (excluding micro finance) went up from 10 to 38 and finance companies from 54 to 74 during the period.

Necessary reforms in the conduct and instruments of monetary policy were also initiated in the last five years. In the early years of making monetary policy public, the bank had adopted an accommodative stance to monetary policy without prejudice to the objective of price stability. The refinance rate for rural development banks and export in local currency was maintained at 4.5 %. The bank views that this provision has provided some relief to sick industries, although there was no full utilization of this facility as per the provision in the Monetary Policies. Cash reserve ratio (CRR) was slashed by 1 % age point and maintained at 8.0 % in 2002/03. This ratio was further lowered to 6 % in 2003/04 and to 5.0 % in 2004/05 with a view to lowering intermediation cost of commercial banks, increasing their loanable funds and helping them to lower the interest rate spread. The bank is of the view that even in the context of internal conflict and political instability, the steps undertaken in monetary and financial sector through annual monetary policy have been helpful in maintaining the overall macroeconomic stability in the last five years. Based on the experiences of the reform programs on monetary, fiscal and external sectors in the past years and by continuing the

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reform programs to address the emerging financial and economic problems, the bank has formulated its sixth annual Monetary Policy for 2064/65.

In the Monetary Policy and the government's Budget Speech of 2063/64, the economic growth of 5.0 % was estimated for that year. The end of internal conflict, improvement in political situation and favorable monsoon were the key bases for that growth projection. As per the recent statistics released by Central Bureau of Statistics (CBS), the real GDP is estimated to have grown by 2.5 % at producers’ prices in 2063/64 compared to a growth of 2.8 % in 2062/63. Monsoon did not remain favorable as expected in the review year. The production of paddy, which contributes 20 % to total agricultural GDP, declined by 12.6 % due to insufficient rainfall, resulting in a fall in food grain production by 4.3 % in 2063/64. The services sector grew by 4.1 % in 2063/64 compared to a growth of 4.7 % in the previous year. Among the services sectors, the wholesale and retail trade sector declined by 2.6 % whereas transport, communications and storage sector witnessed some improvements in the review year.



To enhance its accountability and transparency by designing the various programs related to the above-mentioned objectives.

To facilitating the targeted economic growth of 5.0 % along with achieving the internal as well as external sector stability and financial sector consolidation.

To maintain overall macroeconomic management through appropriate liquidity adjustment by containing the inflation rate of 5.5 % .

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CHAPTER II: PRIMARY FUNCTIONS OF MONETARY POLICY

2.1 MONETARY INSTRUMENTS

The central bank influences interest rates by expanding or contracting the monetary base, which consists of currency in circulation and banks' reserves on deposit at the central bank. Central banks have three main tools of monetary policy: open market operations, the discount rate and the reserve requirements.

Monetary Instruments Reforms in 2062/63

The objective of monetary policy Instrument is to make a proper co-ordination between market interest rate and the bank rate. The bank rate will be determined at 0.5 % age points over the repo rate, in case the repo rate gets higher than the bank rate. Pre-determined bank rate will be effective in case the repo rate is lower than the bank rate. If liquidity need of any commercial banks cannot be fulfilled through OMOs and standing liquidity facilities (SLF), the last resort liquidity facility will be provided to the commercial banks at the bank rate. The refinance rate for export credit in foreign currency as well as domestic currency, agricultural credit has been revised on May 31, 2005. This rate will be continued this year too. However, the refinance rate for sick industries has been kept unchanged at 1.5 % . Over the past few years, the Bank has steadily pursued the policy of gradually reducing the CRRs. In view of existing distress in industries and tourism sector, such sick industry refinance facility will be continued in FY 2062/63. For this year, sick industry refinancing facility has been increased to Rs. 2.0 billion.

In the monetary policy of FY 2004/05, a change was made in the implementation strategy of OMOs. According to this provision, open market instruments such as outright sale auction, outright purchase auction, repo auction and reverse repo, Monetary Policy for FY 2062/63 auction are put in operation. Main objectives of outright sale auction and outright purchase auction are to respectively absorb and inject liquidity of secular nature. Through repo and reverse repo transactions, only collateralized loans are provided and taken respectively by the NRB to and from the commercial banks. Actual purchase and sale of these securities do not take place. Currently, a paper certificate of certain standard is being issued at the time of issuance of treasury bills. Transaction through this process reduces costs and avoids the risk

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of loss and damage of certificate and also lowers administrative hassles. With an objective of making internal liquidity injection/absorption more effective in the process of implementing monetary policy, OMOs in domestic bills was coordinated with foreign exchange intervention of the Bank. According to the provision made in the monetary policy of FY 2004/05, the development bonds amounting to Rs. 3.0 billion was issued through auction. The NRB undertakes OMOs to achieve monetary policy objective at its own initiative. So far, all the repayment of principal of HMG bonds is being carried out solely by the NRB. From this fiscal year on, market makers and commercial banks will also be making principal repayment of HMG’s domestic debt instruments. Few Tables are:

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Source : Monetary Policy FY 2062/63


Secondary open market operations have been an important short-term instruments of monetary policy for the last two years. In secondary open market operation, the sale auction, purchase auction, repo auction and reverse repo auction on the treasury bills of the Government of Nepal have been used to mop-up and inject liquidity. As mentioned above, the bank will continue to conduct sale auction and reverse repo auction on the treasury bills held by it for liquidity management if, due to higher inflow of remittances, commercial banks have the excess liquidity and distortions emerge in the economy. In order to provide the required liquidity, the bank will request the Government of Nepal to issue the necessary direction to the Nepal Security Board to expedite the process of the sale and purchase of the development bonds in the secondary market. In order to determine the long-term market interest rate for a period exceeding ten years and to reflect long-term liquidity, investment and inflation perceived by the economic agents, a long-term 12-year development bond will be issued in 2063/64. After determination of interest rate on 12-year bonds from the auction, citizen saving certificates will be issued with coupon rate taking into consideration the auction determined rate. To expand, facilitate and ease the principal and interest payments of the bonds of the Government of Nepal, besides the market makers, the NRB-licensed institutions of categories "A", "B" and "C" were allowed to make payments of interest and principal of government bonds and seek reimbursement from the NRB. Presently, four types of forms are in use for outright sale, outright purchase, repo and reverse repo auction. To facilitate, simplify and ease the OMOs, the two different forms used for each sales and purchase auction, and repo and reverse repo auction will be integrated into one for each category.

After the introduction of financial liberalization policies, there has been a rapid expansion of financial institutions in the urban areas. To expand the micro credit market and enhance its efficiency, there is a need of legal and institutional reforms. The bank has already submitted the draft of "National Micro-finance Policy" to the Government of Nepal, and the budget speech of 2063/64 has also mentioned the formulation of related laws and its implementation. As stated in the monetary policy 2062/63, the ongoing process of transforming the rural self-reliance fund managed by the bank into the wholesale lending financial institution will be continued in 2063/64. Accordingly, the fund will be transformed into the self-governed and organized 'Micro-finance and Cooperative Institution' by 2063/64. After the introduction of micro-finance umbrella act governing micro-finance development banks, saving and credit

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co-operative societies, and non-governmental organizations undertaking limited banking activities, a second tier institution (STI) will be established under this act in order to regulate, inspect and supervise the microfinance institutions. The remote hilly area of the country is suffering from the widespread incidence of acute poverty but people in these areas have low outreach to credit. Most of the micro-finance development banks have been operating mostly in Terai region. Micro finance institutions operating in rural areas should be strengthened. One of the measures of strengthening is to make equity participation in these situations. Both public and private sector can make equity investment in these institutions. Hence, a provision will be made so that intended national and international institutions can provide resources to the proposed fund. Amount invested by commercial banks in this fund will be considered as a deprived sector lending and foreign companies will get the facility to repatriate the return from

such investment. The above mentioned tables are:

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An analysis of monetary outlook shows that excess liquidity will continue to prevail. Short-term interest rates remained low even after the cumulative absorption of Rs. 32.74 billion excess liquidity in 2063/64. On the other hand, growth of consumer credit has been higher than the growth of credit to the productive sector. An expansion of bank credit towards real estate and stock market has resulted in a rise in asset price substantially. High level of excess monetary liquidity can pose a risk to both domestic (i.e. the price) and external sector stability. In addition, monetary accommodation is warranted to address the risk to financial sector stability emanating from less than expected improvement in loan quality of banks. The additions to the values were to Continue outright sale and purchase auction as usual on multiple pricing auction system, Continue repo and reverse repo auction as usual on multiple-interest auction system, Auction secondary market operation as per the study and analysis of Open Market Operation Committee based on the outcome of LMFF and to be regularly sent to Research department all the above information integrating in different forms.

In 2063/64, this bank had to intervene and take over, for a brief period of time, the management of the Nepal Bangladesh Bank Limited (NBBL). To avert the financial crisis of that bank, credit of Rs. 2.47 billion immediately and Rs. 3.12 billion for a whole year under SLF against the collateral of treasury bills and development bond of the HMG was provided to that bank. In addition, this bank as the lender of last resort provided an exceptional refinancing of Rs. 1.27 billion against the good loans of that bank. Such an intervention and monetary accommodation would create moral hazard problem. To avoid moral hazard like problem, this bank has to provide any monetary accommodation to any bank and financial institution. However, monetary accommodation were granted only to address the problem of systemic risk, emanating from the failure of a particular bank and financial institution.

With the objective of financial sector stability, financial sector reform program, which includes the strengthening of regulatory and supervisory capacity of this bank, has been continued. While the financial situation of the government owned NBL and RBB have been gradually improving, the financial situation of some private commercial banks and development banks has been also a matter of concern. Without improvement of these determinants of growth, Nepal cannot hope to benefit from the higher growth of neighboring countries, China and India, and higher global growth. If the past experience is any guide, monetary and liquidity easing alone cannot guarantee a higher economic growth.

In the existing situation of Nepal, economic growth depends mostly on the abovementioned non-economic factors rather than on monetary factor. In the context of high liquidity and risk to inflation outlook, the stance of the Monetary Policy for 2064/65 is focused on liquidity management and maintenance of macroeconomic stability as before.

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The four auction tables are:

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2.2 BANKING REGULATIONS

Banking Regulations in 2062/63

In this context, for the past couple of years, the NRB had been pursuing an accommodative stance of monetary policy. During this period, policy arrangements were made to help augment the availability of credit in the economy by way of reducing CRR, lowering down of the bank rate and the refinance rates, and reducing the cost of credit through adequate provision of refinance facility for sick industries and exports. The NRB has achieved some success in this regard. In the process, the lending rates of commercial banks have decreased, albeit not sufficient as compared to the past. The credit off-take to the private sector has picked up. The excess liquidity with the commercial banks has declined. As a consequence, the profit of the banks has increased. The possible risk to economic growth also requires the continuation of the current soft monetary policy stance. With a view to develop the NRB into a modern central bank, capable in maintaining financial sector stability, the second phase of financial sector reform will focus on updating the information technology, supervisory capability and human resource management. Moreover, the accounting system of the NRB will be updated to comply with the requirements of international accounting standard and Nepal accounting standard.

The Bank will formulate and bring into implementation from this fiscal year a medium term strategic planning (2062/63-2066/67). This planning will include the road-map in attaining the objectives of the Bank as laid down by the NRB Act 2002; and the mission and vision as determined by the Bank. The proposed strategies, activities and its work-plan will also deal with the human and other resources that will be required to achieve the vision and mission statements. Following the policy of financial sector liberalization in the past two decades or so, a large number of financial institutions have come into operation. Qualitative development of banking and financial services require appropriate management of their numerical growth. Merging of a bank and non-bank financial institution (NBFI) with another one, or a bank and NBFI acquiring others into itself, is a natural and an inevitable consequence of a soundly functioning financial system.

The Bank and Financial Institutions Ordinance (BFIO) and the Company Act contain the provision of merger and acquisition. Based on these, a finance company got successfully merged with a commercial bank recently. A few number of similar institutions are in the process of acquiring and merging within the provision of existing legal framework. The NRB strongly feels the need to streamline and simplify the existing process of merger and acquisition such that Nepal's banks and NBFIs get transformed into vibrant and resilient intermediaries by means of mergers and acquisition. In this direction, this bank will initiate the review of existing legal framework. Likewise, the process of Bank rationalization has been put in place and voluntary retirement scheme (VRS) has been introduced. Through this process, the total number of staff of the Bank has been reduced to 2,960 from 6,322.

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The current provision of providing forex facility of up to USD 1500 to individuals and institutions by commercial banks for settling petty international transactions for various purposes has been raised upward from USD 1500 to USD 2500. Moreover, existing system of making payment through telex/wire/draft, has been expanded to include credit card and debit card as well. Effective from 2063/64, the exchange facility of USD 5000 for individual migrant and USD 10000 for family migrants to the developed countries like the USA, Canada, Australia, New Zealand and the UK under immigration visa will be made available directly from the commercial banks by endorsing the amount in the passport. Commercial banks are free to open an LC even for payment period of more than a year. In order to enhance the competitive capacity of the industries in Nepal, the current list of 91 raw materials and intermediate products eligible for import from India by paying US dollar will be gradually increased. To encourage entrepot trade in consistence with the global practices, Nepali importers importing goods through L/C will be allowed to export to any other countries, without entering Nepal, at the prices which is higher than the import prices. Understanding the inadequacy in the existing exchange facility of up to USD 300 at a time to individuals having visa for private visit by surface route to autonomous region of China, Tibet (except rule based visitors) as well as SAARC countries other than India, the facility has been increased from USD 300 to USD 1000. From 2063/64, commercial banks have been allowed to accept documents in access of amount stated in import L/C in convertible currency in excess of any amount stated in import L/C. The restriction on payments for goods imported without LC or on imports when actual imports differs from the initial LC and no amendment is made on this LC has been withdrawn from 2063/64. Now, commercial banks are allowed to amend the LC based on Already Shipped Documents. But, in imports entering from places other than Kolkata port of India before amending Already Shipped Documents, commercial banks must receive the authorized letter from concerned offices clearly indicating the details of goods.

From 2063/64, following measures have been introduced in regards to the existing provision of the licensed money changer firm/company to exchange the convertible currencies they have purchased with the commercial banks

The money changer firms/companies can sell their convertible currencies to the commercial banks,

Money changer firm/company can open foreign currency account in the bank and financial institutions under the existing rules, and

These companies are allowed to provide foreign exchange for passport facility as per the existing rule.

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Keeping into consideration the increased attraction towards the foreign employment and the contribution of the manpower companies in the development of this sector, if these companies want to legally operate their branches/representative offices/ contact offices abroad, NRB will provide the necessary exchange facility to run their offices on the recommendation of the concerned departments of the Government of Nepal. In the market economy, there is always exchange rate risk emanating from the fluctuation in the exchange rates. The use of derivative instruments has been extended in these days as a measure to hedge such risks. In this context, the commercial banks are not required to take approval of NRB while trading in derivative instruments like forward, option, swaps and futures provided such trading takes place as per the criteria set by the Board of Directors of the respective commercial banks. This provision is expected to increase the involvement of commercial banks in risk management.


The Budget Speech for 2064/65 has stated the approval of the working procedure for establishing an Industrial Rehabilitation Fund for the rehabilitation of sick industries from internal conflict. The bank has taken the policy of adopting capital adequacy structure as per the international standard, based on the new standard of BASEL II. necessary changes was made on single borrower limit to ease the loan disbursement for infrastructure development The private sector banks and financial institutions will be encouraged to set up and operate the proposed Nepal Infrastructure Development Bank for the long term project investment. E-banking directives will be issued in 2064/65 in the context of expanding electronic banking in Nepal. The accounting system of the NRB was gradually be upgraded as per the international accounting standard. The risk-based supervision approach was implemented for each bank and financial institution separately in a planned way. The establishment of the Insolvency Administration Office and Secured Transaction Registrar's Office. The scope of investment and capital market was expected to expand by restructuring the assets such as loans and other assets held by financial and other institutional sectors, and issuing appropriate securities against.

In order to reduce the concentration of risk originating from the loan disbursement and to ease the availability of loans on the different sectors of the economy, the existing fund based limit of 25 % of primary capital and non-fund based limit of 50 % of the primary capital will be changed as per the international practice for inspection and supervision as well as the BASEL Core Principles (BCP) adopted by the NRB. Accordingly, a policy of gradually lowering the single borrower limit including the non-fund based to 25 % of the primary capital by 2010 has been adopted.

In order to make the NRB an effective regulatory body and to let the financial institutions operate completely in private sector, the process of divestment of shares of various financial institutions owned by the NRB will be continued as per the provisions of the NRB Act, 2002. The NRB Act 2002 has categorically mentioned that this bank cannot invest in the share of any bank and financial institution more than 10 % of the paid up capital of such institutions.

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Accordingly, the shares in the Western, and the Eastern Rural Development Banks have already been sold. The share ownership of this bank in the Central Rural Development Bank will be divested to the private sector in 2064/65. Further, due diligence audit (DDA) of other rural development banks will be carried out in the process of their privatization.

2.3 LIQUIDUTY MANAGEMENT

Liquidity is the availability of funds, or assurance that funds will be available, to honor all cash outflow commitments (both on- and off-balance sheet) as they fall due. These commitments are generally met through cash inflows, supplemented by assets readily convertible to cash or through the institution’s capacity to borrow. The risk of illiquidity may increase if principal and interest cash flows related to assets, liabilities and off-balance sheet items are mismatched. Managing liquidity is a fundamental component in the safe and sound management of all financial institutions. Sound liquidity management involves prudently managing assets and liabilities (on- and off-balance sheet), both as to cash flow and concentration, to ensure that cash inflows have an appropriate relationship to approaching cash outflows. This needs to be supported by a process of liquidity planning which assesses potential future liquidity needs, taking into account changes in economic, regulatory or other operating conditions. Such planning involves identifying known, expected and potential cash outflows and weighing alternative asset/liability management strategies to ensure that adequate cash inflows will be available to the institution to meet these needs.

Liquidity Management 2062/63

Transparency is one of the pillars of effective conduct of monetary policy. As per article 94 of the NRB Act, 2002, the NRB has been making monetary policy public at the beginning of fiscal year. The report includes the evaluation of the implementation of previous year's monetary policy and justification of policy measures for the current fiscal year. This report is the fourth of this kind. The annual monetary policy statements including its semi-annual evaluation are published with a view of ensuring the transparent implementation of monetary policy. Both of these reports include implementation situation of monetary policy, measures undertaken with respect to foreign exchange reserve management, reforms in external sector; and the status of the regulation, inspection and supervision of the financial sector. This year’s monetary policy stance is thus a reflection of the situation of these sectors and the stated objectives of monetary policy.

Currently, treasury bills, development bonds, and national saving certificates (NSCs) and citizen saving certificates (CSCs) of the government are being issued targeting commercial banks, banks and financial institutions and general public (household) respectively as the intended clientele. Further, in the context of collecting tax, special bonds are being issued to reconcile the liabilities of HMG with the private sector. With a view to streamline the

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number of securities issued in mobilizing public debt, a system of issuing only treasury bills, development bonds and CSCs will be introduced. Moreover, the CSCs will be made eligible as collateral in obtaining loans from banks and financial institutions. HMG will be requested to issue temporary special bonds instead of currently being issued special bonds and to make prompt payment by shortening administrative processes. In case, the prompt payment becomes difficult, the temporary special bonds should be liquidated by issuing treasury bills, development bonds or national saving certificates.

According to the provision made in the monetary policy of FY 2004/05, the development bonds amounting to Rs.3.0 billion was issued through auction. Such development bonds with 5.5 % coupon rates and having a maturity period of five years were oversubscribed and sold at premium in all auctions. Such bonds have already been listed in Nepal Stock Exchange (NEPSE) Limited for secondary market transactions. Taking the situation of money and capital market into account, in the current fiscal year too, as in the last year, some portion of domestic borrowing proposed in the budget will be issued through the auction of development bonds.


Despite various measures undertaken to reduce the NPL of NBL and RBB, the NPL ratio in these two banks could not improve effectively due to the reluctance of some large borrowers to pay back the loan. Debt recovery is not the big problem from small and medium borrowers. The large wilful defaulters cite the unsatisfactory macroeconomic situation of the country as the cause for their inability to repay bank loans. Following the amendment of the blacklisting provision, the large borrowers have been creating obstacles in debt recovery citing the limited liability concept. A group of large borrowers in government-owned commercial banks have been obdurate in repaying their loans for several years. A fast recovery of these banks' loans is not possible only through the preventive financial sector reform programs and strengthening of the inspection and supervision capacity of this bank. As done in the other countries encountering similar problems, there is an urgent need in Nepal, too, to compel the large borrowers to make their business transactions transparent, to publicly disclose their property, to take the legal actions on false declaration of the property and to impose harsh punishment on these defaulters after providing certain cut-off time period. Moreover, the curative measures as well as one time settlement for such loan needs to be introduced. For this, the bank seeks the support and cooperation from all stakeholders including the Government of Nepal.

Monetary liquidity expanded in 2062/63. The commercial banks also had a significant level of excess liquidity. A part of the excess cash liquidity of commercial banks was mopped up through the fresh issue of government securities amounting to Rs.11.9 billion as stated in the budget speech for 2062/63. In addition to this, the NRB sold treasury bills worth Rs.13.5 billion through outright sales auctions mopping up further excess cash liquidity from the banking sector. For mopping up short-term excess liquidity, the bank also undertook the reverse repo auction of Rs.6.5 billion. The economy witnessed excess liquidity owing mainly

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to the significant growth in private sector's remittances. Such an excess liquidity emerged due to a higher growth of time deposits relative to a growth of the private sector credit off-take in the economy.


The share market has expanded in 2063/64. The NEPSE (Nepal Stock Exchange) index increased by 76.8 % in 2063/64 to 684.0 compared to an increase of 35.0 % in 2062/63. The market capitalization (Rs. 186 billion) to GDP ratio went up to 25.9 % in 2063/64 from 15.0 % in 2062/63. Improvement in the health of financial institutions, expansion in monetary liquidity, low interest rate and lack of alternative investment opportunity were the factors responsible for the expansion of share market. An excessive increase in share price, not supported by overall economic activities, can hinder the share market in the future. If the share price takes the form of bubble and bursts, adverse consequences will emerge in the economy. The bank has taken a cautious note of the rise in asset price, besides the prices of goods and services.

Inter bank transactions, an important money market activity, amounted to Rs. 170 billion in 2063/64 compared to Rs. 176 billion in the previous year. Although interbank transactions remained at a lower level compared to that of the previous year, the use of standing liquidity facility (SLF) by commercial banks from the NRB increased. For example, commercial banks availed SLF amounting to Rs. 46.98 billion in 2063/64 compared to Rs. 9.88 billion in 2062/63. Such an increase in the use of SLF by commercial banks despite excess monetary liquidity situation in financial market is a matter of concern. The NRB will adopt the monetary measures to arrest this trend. The system of taking the excess liquidity of commercial banks as operating target of monetary policy will be continued. This bank will continue the preparation of LMFF based on its weekly balance sheet. The liquidity of the commercial banks indicated by this framework will be regularly monitored and OMO as a monetary measure will be conducted accordingly.

2.4 EXCHANGE RATE/FOREIGN EXCHANGE RESERVE

Foreign-exchange reserves (also called forex reserves or FX reserves) is money or other assets held by a central bank or other monetary authority so that it can pay if need be its liabilities, such as the currency issued by the central bank, as well as the various bank reserves deposited with the central bank by the government and other financial institutions. A central bank that implements a fixed exchange rate policy may face a situation where supply and demand would tend to push the value of the currency lower or higher (an increase in demand for the currency would tend to push its value higher, and a decrease lower) and thus the central bank would have to use reserves to maintain its fixed exchange rate.

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Foreign Exchange Reserve for 2062/63

Considering the slow growth of private sector, the unstable financial sector and the possibility of economic crisis due to external shocks on our weak economy, Nepal has adopted a policy of gradually and cautiously opening up its external sector. The proposed foreign exchange sector reforms for FY 2062/63 are a reflection of such situation. In order to simplify and impart convenience to the needy, the current provision of providing forex facility of up to US$ 1,000 to individual and institutions by commercial banks for settling petty international transactions for various purposes has been revised upward to US$ 1,500. Also, the demand of people have been addressed by a provision of providing US$ 5,000 for an individual and US$ 10,000 for a family for Nepali citizen permanently migrating to the developed countries like the USA, Canada, Australia, New Zealand and the UK. To promote tourism and export, the firms/institutions/companies having the source of foreign exchange earnings can use their foreign currency account held with commercial banks in Nepal while making payments in foreign currency to promote their business in the countries except India. Also, effective from FY 2062/63, a provision has been made whereby the spouse and the parents of foreign exchange account holders will be allowed to operate his/her forex deposit account held with banks in Nepal after obtaining the prior permission from such account holders.

In a situation of receiving the document in excess of the amount than stated in import L/denominated in convertible currency, a provision is made under which commercial banks can accept a document up to 2 % of the L/C amount or US dollar 1,000 whichever is lower. In case of failure to make use of cheque issued in favour of concerned customs office while releasing the document or sending advance payment under draft/T.T. or import L/C denominated in convertible currency, a provision has been made for extending the validity of such cheques by concerned commercial banks themselves under the condition that the concerned party apply to the bank within 90 days of the issuing of the cheque with sufficient supporting evidences. Commercial banks are free to swap the interest rate while hedging the interest rate of the loan borrowed by any party in foreign currency. In order to provide additional incentive to private sector to import chemical fertilizer, and lower the cost to farmers, the requirement to deposit 10 % of import value in commercial banks or producing bank guarantee is reduced from 10 % to 2 % . International agencies located in Nepal that hold foreign currency deposit account with the Nepali commercial banks, can make payments in India in convertible currency, by debiting their forex deposit accounts held at the Nepali commercial banks.

The provision of exchanging foreign currency under passport facility only once in a fiscal year has been terminated. Under the revised provision anybody who intends to borrow from abroad, for a period of one year and above, can just notify the NRB without pledging any domestic asset as collateral. In order to make the Nepali entrepreneurship competitive in the

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international market by allowing Nepali entrepreneurs to invest in foreign countries and help attract foreign direct investment (FDI), and also bring modern technological know-how and managerial skills inside the country, the NRB will request HMG either to repeal or amend the existing Foreign Investment Prohibition Act (FIPA), 1964. From FY 2062/63, NRB will sell silver to local exporters of ornaments and utensils from its own stock at the prevailing international market prices. To make Nepal's exports further competitive, there will be further addition in the number of industrial raw materials and intermediate as well as capital goods that will be eligible for imports from India against the payments of US dollars.


The current provision of providing forex facility of up to USD 1500 to individuals and institutions by commercial banks for settling petty international transactions for various purposes has been raised upward from USD 1500 to USD 2500. Moreover, existing system of making payment through telex/wire/draft, has been expanded to include credit card and debit card as well. Effective from 2063/64, the exchange facility of USD 5000 for individual migrant and USD 10000 for family migrants to the developed countries like the USA, Canada, Australia, New Zealand and the UK under immigration visa will be made available directly from the commercial banks by endorsing the amount in the passport. Commercial banks are free to open an LC even for payment period of more than a year. In order to enhance the competitive capacity of the industries in Nepal, the current list of 91 raw materials and intermediate products eligible for import from India by paying US dollar will be gradually increased. To encourage entrepot trade in consistence with the global practices, Nepali importers importing goods through L/C will be allowed to export to any other countries, without entering Nepal, at the prices which is higher than the import prices. Understanding the inadequacy in the existing exchange facility of up to USD 300 at a time to individuals having visa for private visit by surface route to autonomous region of China, Tibet (except rule based visitors) as well as SAARC countries other than India, the facility has been increased from USD 300 to USD 1000. From 2063/64, commercial banks have been allowed to accept documents in access of amount stated in import L/C in convertible currency in excess of any amount stated in import L/C. The restriction on payments for goods imported without LC or on imports when actual imports differs from the initial LC and no amendment is made on this LC has been withdrawn from 2063/64. Now, commercial banks are allowed to amend the LC based on Already Shipped Documents. But, in imports entering from places other than Kolkata port of India before amending Already Shipped Documents, commercial banks must receive the authorized letter from concerned offices clearly indicating the details of goods.

From 2063/64, following measures have been introduced in regards to the existing provision of the licensed money changer firm/company to exchange the convertible currencies they have purchased with the commercial banks:

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The money changer firms/companies can sell their convertible currencies to the commercial banks,

Money changer firm/company can open foreign currency account in the bank and Financial institutions under the existing rules, and

These companies are allowed to provide foreign exchange for passport facility as per the existing rule.

Keeping into consideration the increased attraction towards the foreign employment and the contribution of the manpower companies in the development of this sector, if these companies want to legally operate their branches/representative offices/ contact offices abroad, NRB will provide the necessary exchange facility to run their offices on the recommendation of the concerned departments of the Government of Nepal. In the market economy, there is always exchange rate risk emanating from the fluctuation in the exchange rates. The use of derivative instruments has been extended in these days as a measure to hedge such risks. In this context, the commercial banks are not required to take approval of NRB while trading in derivative instruments like forward, option, swaps and futures provided such trading takes place as per the criteria set by the Board of Directors of the respective commercial banks. This provision is expected to increase the involvement of commercial banks in risk management.


There is an existing provision of issuing import Letter of Credit (L/C) on the basis of C.I.F (Cost, Insurance and Freight) and C & F (Cost and Freight). As there is a possibility of reduction in the cost pertaining to freight and insurance when a importer himself makes the arrangements related to freight and insurance, a provision will be made so that the L/C can be issued on the basis of F.O.B (Free on Board) also. While the existing provision is such that it is possible to import only through the L/C or through Draft/TT for goods whose value do not exceed US$ 30,000, an arrangement to import through the mechanism of Documents against Payment will be made. In order to enhance the competitive capacity of the industries in Nepal, the existing policy of increasing the number of raw materials and intermediate products that can be imported from India against the payment of US dollar will continue to be added in the current list of 121.

An arrangement will be made whereby the exchange facility of US$ 5,000 per Nepali citizen migrating on immigrant visa to the developed countries like the USA, Canada, Australia, New Zealand and the UK can be provided by the licensed banks or financial institutions by endorsing such a facility in the passport. An arrangement will be made whereby the practice of obtaining approval for the required exchange facility from the bank by the registered insurance companies in Nepal for paying reinsurance fee to foreign-based reinsurance company exchange facility can be provided directly by the licensed bank and financial institutions on the recommendation of the Insurance Board together with the necessary documents. The existing rule of the requirement of NRB’s approval on foreign currency refund in case of it already being credited into the beneficiary’s account was abolished and a

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provision was be made so that the related commercial banks and financial institutions could make the refund on the basis of the necessary documents.

The name of Nepalese companies receiving foreign currency under Global Tender was to be added under the list of individuals or institutions that have sources of foreign currency and are entitled to open foreign currency deposit accounts. Beginning this year, tickets issued in Nepal for those who start their travel from different cities of India to different countries will also be defined as confirmed tickets and the foreign currency exchange under passport facility will be provided to them from the banks and financial institutions. The existing provision of 2 % service charge on the sale of foreign currency in cash by the banks and financial institutions to the NRB has been reduced to one % considering the existing condition of the market. By this provision, the commission rate of banks and financial institution on the purchase of the foreign currency from the public will decline at the same proportion. In the context of exchange rate fluctuations occurring in foreign currency exchange market and creating exchange rate risk to parties involved in foreign exchange transactions leading to loss in certain circumstances, limiting the forward exchange transactions to L/C only does not seem logical.

Hence, the forward exchange transactions will be opened under the condition that the related bank shall bear the cover and risk of profit/loss arising from such transactions as per the policy given by the board of directors of the concerned commercial banks. There exists no policy for Nepalese to make investment abroad. Banning Investment Abroad Act, 2021 is the obstacle for this. To legalize the investment aboard, the draft of 'Regularizing the Foreign Investment Abroad Bill, 2006', has been submitted to the Ministry of Finance. Since the Budget for 2064/65 of the HMG has also expressed the concern on the investment abroad, it is believed that this bill will be enacted soon. Subsequently, the NRB will prepare the other operational guidelines pertaining to it.

2.5 MONEY SUPPLY

The money supply is commonly defined to be a group of safe assets that households and businesses can use to make payments or to hold as short-term investments. For example, U.S. currency and balances held in checking accounts and savings accounts are included in many measures of the money supply. Over some periods, measures of the money supply have exhibited fairly close relationships with important economic variables such as nominal gross domestic product (GDP) and the price level. Based partly on these relationships, some economists have argued that the money supply provides important information about the near-term course for the economy and determines the level of prices and inflation in the long run. Central banks around the world, have at times used measures of the money supply as an important guide in the conduct of monetary policy. NRB, regularly reviews money supply data in conducting monetary policy, but money supply figures are just part of a wide array of financial and economic data that policymakers review.

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Money Supply 2062/63

During the first eleven months of FY 2004/05, M2 expanded by 6.5 % (Table 5, Fig. 6). M2 had increased by 9.2 % in the same period of the previous year. Relatively lower growth of NFA accounted for a slower growth of M2 in FY 2004/05 compared to that of FY 2003/04. NFA (adjusting the foreign exchange valuation) of the banking system, an expansionary factor of money supply, increased by 7.0 % (Rs. 7.65 billion) during the first eleven months of FY 2004/05, compared to a much higher growth of 14.5 % in the same period of the previous year. Slowdown in foreign loans led to a lower growth in NFA in the review period compared to that of the previous year. Domestic credit of the banking sector increased by 9.7 % in the first eleven months of FY 2004/05. Domestic credit had increased by 6.6 % in the same period of the previous year. Among the components of domestic credit, the rate of decline of credit flow to government slowed down in FY 2004/05. Credit to private sector increased by 14.8 % in FY 2004/05 compared to a rise of 12.6 % in FY 2003/04. Credit expansion in infrastructure such as hydroelectricity, school and hospital; and consumer financing by private sector banks contributed to an increase in bank credit to private sector. Similarly, expansion of credit to non-financial enterprises such as Nepal Oil Corporation (NOC), Royal Nepal Airline Corporation (RNAC) and National Trading Ltd. by the commercial banks contributed to a higher expansion of domestic credit in FY 2004/05.

During the first eleven months of FY 2004/05, time deposit with commercial banks increased by 7.1 % . Time deposit in commercial banks had increased by 11.1 % in FY 2003/04. Slower GDP growth contributed to a deceleration in time deposit growth to some extent in FY 2004/05. Reduction in CRR; and the provision of collateral based transparent and automatically available SLF led to a rise in credit off-take, resulting in a lower level of the excess liquidity of commercial banks, which in turn, contributed to an increase in the value of money multiplier.


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The broad money (M2) increased by 14.0 % amounting to Rs. 395.32 billion in the review year compared to 15.6 % in 2062/63. The ratio of M2 to GDP increased marginally to 54.9 % compared to 53.6 % in the preceding year. The narrow money (M1), which had increased by 14.2 % in the preceding year increased by 12.1 % in the review year. Another component of M2, time deposit, which grew by 16.4 % in the preceding year, recorded a growth of 14.9 % in the review year. The expansion of monetary aggregates remained subdued in the review year on account of a substantial slowdown in the growth of net foreign assets (NFA) after adjusting foreign exchange valuation gain/loss. Of the components of M1, currency in circulation increased by 7.4 % to Rs. 83.52 billion in the review year compared to a growth of 13.3 % in the preceding year. Sluggish economic activities and a lower level of remittance inflow were attributed to slowdown in growth of currency in circulation in the review year. However, demand deposits increased by 22.4 % in the review year compared to a growth of 16.0 % previous year. Expansion in consumer loan and rising margin lending against share increased the demand deposits in the review year. The demand side perspective reveals that the nominal demand for money remained lower on account of low economic growth and inflation in the review year.

Against a decline of 0.3 % in the preceding year, claims on financial institutions increased by 1.1 % in the review year. Besides the decline in claims on government financial institutions, a growth of claims on non-government financial institutions contributed to the increase in claims on financial institutions in the review year. An increase in short-term placement at finance companies and other financial institutions by commercial banks contributed to the rise in claims on non-government financial institutions. Net non-monetary liabilities grew by 9.9 % in the review year compared to a growth of 13.1 % in the preceding year. A slowdown in the growth of retained earnings and other liabilities of commercial banks contributed to a lower growth of net non-monetary liabilities in the review year. Net domestic assets obtained after deducting net-non-monetary liabilities from the domestic credit expanded by 20.5 % in the review year. Such assets had grown by 11.1 % in the preceding year. Compared to a growth of 14.9 % in the preceding year, reserve money increased by 7.6 % in the review year. A slowdown in growth of NFA of monetary authority on account of a lower growth of remittance inflow contributed to such a slowdown in the growth of reserve money in the review year. Of the components of reserve money, currency in circulation increased by 7.4 % in the review year compared to a growth of 13.3 % previous year. Similarly, the growth of cash in hand of commercial banks decelerated to 21.6 % in the review year from 23.8 % in the preceding year. Likewise, against the growth of 13.2 % in the preceding year, deposits of commercial banks with NRB declined by 0.2 % in the review year.


The bank rate will be used for signalling monetary policy stance and for providing lender of last resort facility from this bank in case of systemic risk. This rate has also been used to impose penalty on the amount of shortfall if any commercial bank fails to maintain the CRR. The bank rate has been kept unchanged at 6.25 % . Since there is no perceivable

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improvement in Nepalese industries and tourism businesses, the sick industry refinance facility of Rs. 2.0 billion has been continued for 2064/65 as well. The sick industry refinance facility has been put in place since 2002/03. The facility will be provided in line with the existing terms and conditions. The amount sanctioned for it will be channelized through the proposed Industrial Rehabilitation Fund. The bank rate will be used for signalling monetary policy stance and for providing lender of last resort facility from this bank in case of systemic risk. This rate has also been used to impose penalty on the amount of shortfall if any commercial bank fails to maintain the CRR. The bank rate has been kept unchanged at 6.25 % .

The provision of carrying out the sale and the purchase auction on the multiple prices, and the repo and the reverse repo auction on multiple interest rates, has been continued. The existing system of secondary market operations on every Wednesday, under the initiation of this bank, will be continued. The provision of carrying out open market operation on any other day of week depending upon the development of monetary situation has also been maintained. SLF will be provided to the commercial banks as usual, on the collateral of the treasury bills and the developments bonds of the HMG. This facility, that is to be provided under the initiation of commercial banks, has been used substantially, amounting to Rs. 46.98 billion in 2063/64 compared to Rs. 9.88 billion in the preceding year. In the context of commercial banks providing substantial amount of short-term credit to the development banks and finance companies, the penal rate has been increased from 1.5 % to 2.0 % to check the misuse of SLF. Open Market Operations Committee (OMOC) will revise the rate depending upon the situation. The existing provision of granting this facility for a maximum period of five days has been kept unchanged.

2.6 INFLATION

Inflation is defined as a sustained increase in the general level of prices for goods and services in a county, and is measured as an annual % age change. Under conditions of inflation, the prices of things rise over time. Put differently, as inflation rises, every unit of money buys a smaller % age of a good or service. When prices rise, and alternatively when the value of money falls, there is inflation. Inflation is caused by an oversupply of money in the economy. Central banks attempt to limit inflation and avoid deflation in order to keep the economy running smoothly. It does this with the help of guiding monetary policy.

Inflation 2062/63

The Nepalese economy, which had registered a good performance during the early 1990s, is experiencing a setback and registering modest growth in recent years. The decade long insurgency induced social tensions and political instability which have caused growth to fall significantly below trend. Real GDP growth decelerated to 2.5 % in 2004/05 from 3.4 % in 2003/04. A decline in agricultural production owing to unfavorable weather conditions, negative growth of the construction and trade, hotel and restaurant sub-sectors and slowdown in the growth rate of some other non- agricultural sub-sectors dampened the growth

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momentum. While growth in agriculture decelerated to 2.8 % in 2004/05 from 3.9 % in 2003/04, non-agriculture GDP growth rate declined to 1.6 % in 2004/05 from 2.9 % in 2003/04. Risks to growth still persist. Weather condition this year have also remained unfavorable which resulted in modest economic growth.

Despite the low rate of economic growth, insurgency and political instability, Inflation remained low and controlled in recent years. The CPI-based average annual rate of inflation remained low at 4.5 % in 2004/05, albeit a pick Lip from % in 2003/04, nonetheless, inflation remained broadly in line with the South Asian regional average. Restrained monetary expansion, prudent fiscal policy and the pegged exchange rate arrangement with the Indian currency have contributed to maintain the rate of inflation below the -S % level. However, a build-up in inflationary pressure expected in 2062/63, a pick-up in global inflation, an increase in the VAT rate from 10 % to 13 % in January 2005, and the adjustment in fuel prices by Nepal Oil Corporation (NOC) in January and September 2005 have contributed to the recent surge in inflation. However, with the peg, inflation in Nepal is expected to align with the trend in the region. Should any deviation occur, the magnitude of deviation from the regional level of inflation will not exceed 2-3 % age points in 2062/63.

The overall external sector remained stable despite the shock emanating from the elimination of the textile quota and the negative impact of insurgency on tourism. Both the current account and overall balance of payments remained in surplus, total exports rose by 10.6 % in 2004/05 mainly due the significant growth of 33.3 % in exports to India. Total imports fell by 0.7 % , reflecting stagnation in economic activities. Formal inflows of remittances is the single largest source of foreign exchange accounting for approximately 12 % of CDP.

Remittances, the mainstay of the Nepalese economy, have contributed 10 sustaining macroeconomic stability. In the face of a significant fall in foreign aid, travel receipts and exports, persistent rising inflows of workers' remittances contributed to the current and overall balance of payments surplus. A significant increase in remittances has also contributed to the accumulation of international reserves sufficient to meet the country's international obligation and to cover 7.5 months' of imports of goods and services. Remittances have exerted positive microeconomic impact especially in poverty alleviation. This is evident from the result of the second Nepal Living Standards Survey, which showed a reduction in absolute poverty level from 42 % in 1995/96 to 31 % in 2003/04. Despite the situation of unease, the budget deficit has been kept in check. Nepal's fiscal deficit stands lower than the South Asian average. This also contributed to maintain macroeconomic stability in the country.

The fiscal deficit, on cash flow basis, remained more or less at the preceding year's level of 2.6 % of GDP in 2004/05. Net domestic borrowing also remained below 1 % (0.9 % ) Of GDP in 2004/05. Domestic revenue collection rose to 13.3 % of GDP in 2004/05, up from 12.6 % in 2003/04. The growth of broad money decelerated to 8.3 % in 2004/05 from 12.8 % in 2003/04. Lower NFA accumulation together with containment of domestic credit slowed the growth of broad money.

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Inflation 2063/64

A major objective of Nepal Rastra Bank (NRB) is to maintain price stability. Accordingly, NRB makes inflation rate projection in the announcement of annual monetary policy and attempts to control the estimated level of inflation during the period. The average annual inflation rate projected for the fiscal year 2063/64 is 6.0 % . While projecting the inflation for the current FY 2063/64, it is assumed that the rate may move upward due to the probable unexpected rise in prices of petroleum products to 9.0 % . There are some major assumptions of the projections:

Lagged effect of hike in petroleum prices of February 2006. Favorable weather condition for the production of grains and cereal articles Indian inflation would remain within the range of 5.0- 5.5 % as estimated by RBI for

FY 2063/64

On the eve of the FY 2063/64 (mid-July, 2006) headline inflation in several countries firmed up in response to sustained pressures from record high international crude oil prices. Many central banks, thus, tightened their monetary policies to contain inflation and inflationary expectations. In Nepal, NRB also announced slightly tightened Monetary Policy for FY 2063/64 with projecting annual average rate of inflation to be 6.0 % . However, the policy recognized the fact that the projection might be about 3.0 % age point higher if the Government of Nepal revised upward the prices of petroleum products. In the first month of the FY 2063/64 (mid-July 2006 - mid-Aug. 2006), headline inflation in Nepal as measured by National Urban Consumer Price Index (NUCPI) stood at 6.9 % . Along with higher oil prices, primary food articles (rice & rice products, pulses etc.) and transportation fares also posed upward pressure in inflation.

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Inflation 2064/65

Inflation has been in the low double digits but has recently come down to below 10 % . Price movements in Nepal have largely mirrored India’s because of the open border between the two counties. In Nepal monetary stance cannot sustain prices that differ from Indian prices for a long time as price differentials cause smuggling; changes in monetary stance eventually shows up in the changes in international reserves. Inflation is now at 9.6 % (annual average CPI, based on 11-months data in FY11) similar to FY10 but down from 12.6 % in FY09. Inflation has been high because of imported Indian inflation, high international commodity prices. Nepal’s own transportation and distribution rigidities often add to price fluctuations especially for foods in the hills and mountains. Wage increases have also contributed significantly to inflation (see below). While Indian inflation was higher than Nepal’s for the most of FY11, prices on both sides of the border have recently converged–again, reflecting open border and the pegged exchange rate.

Inflation in Nepal is spearheaded by food prices, which makes up 47 % of the Consumer Price Index. The largest increases were seen in vegetable, fruit, sugar, and milk prices which increased by 47, 28, 23, and 17 % (12 months), respectively, as of the end FY11. Cereal and grain prices increased about 10 % . The timely and good monsoon seen in 2011 will increase FY12 outputs, with the possibility of lowering the pressure on food prices in the near future. Despite this generally positive trend, parts of the country may still face a food deficit due to inaccessibility associated with limited infrastructure development. Compared to food price increases, nonfood and services prices remained relatively stable, with only a 4 % increase in FY11. The prices for petroleum products and coal rose by 13.4 % (12 months) at the end of FY11. Wages have been rising faster than consumer prices; the wage index rose by 31 % y-o-y in FY11 (measured in mid-June). Agricultural labor wages rose fastest, at 40 % , followed by regular worker wages (33 % ) and wages for construction workers (30 % ). Large scale outflow of migrant workers and the resulting worker shortages also explain the wage increases. In addition, huge remittance inflows in the recent past have increased aggregate demand (i.e., consumption) without raising the nation’s production capacity

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CHAPTER III: DEVELOPMENTAL FUNCTION OF MONETARY POLICY

The developmental functions of monetary policy can be narrowed down into the following:

3.1 FINANCIAL ADVISOR OF GOVERNMENT

The most important developmental function of monetary policy is that it is the financial advisor of the government. Monetary policy consists of all the ways through which the government is supposed to utilize a country’s fund. It guides the government regarding which sector needs what kind of investment and which sector of the country needs economic reform. A government performs all its financial activities for a particular year by staying within the framework of the monetary policy.

FISCAL YEAR 2062/63

Nepal is gradually turning into a liberal and market friendly economy. In the context of obtaining the membership of the WTO, Nepal has committed to allow the operation of branches of foreign banks from 2010. In this context, so as to make the existing institutions capable of absorbing the external shocks, this Bank wants to strengthen the capacity of banks and financial institutions. To achieve these objectives, the NRB in FY 2062/63 is undertaking various financial sector reforms programmes. The capital adequacy ratio (CAR) to be maintained by bank and financial institutions (BFIs) was set at 12 % of their total risk weighted assets from FY 2003/04. But, taking into consideration the difficult situation of the country, such rate had been fixed at 11 % for both FY 2003/04 and FY 2004/05. Now, taking into account the present capital fund position of BFIs, such ratio has been raised to 12 % , with core capital requirement set at a minimum of 6 % for FY 2062/63. With an objective of strengthening the supervisory capacity of NRB, the Inspection and Supervision By-Law, and On-site Inspection Manual both of which are in implementation since FY 2004/05, has been reviewed and updated. Moreover, off-site supervision manual has also been drafted, finalised and brought into implementation. It had expected to enhance the efficiency of off-site supervisory role and the results were too good.

FISCAL YEAR 2063/64

NRB was in the process of implementing BASEL II from 2007. Accordingly, required capital adequacy ratio (CAR) was decided according to BASEL II provision. In this context and the difficult situation through which banks and financial institutions had to pass through in the previous years, the capital adequacy ratio has been set at 11 % (to be accounted from 2062/63) until new capital adequacy ratio is set based on BASEL II. Up to 2004/05, bank and financial institutions were required to maintain a CAR of 11.0 % . They were required to raise it to 12.0 % from 2062/63. NRB had also made necessary endeavors to co-ordinate the

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commercial banks and entrepreneurs so as to raise the capital fund of the Fund up to Rs.2.0 billion. Similarly, for establishing the Fund, NRB had formulate the necessary process and provisions.

FISCAL YEAR 2064/65

In order to reduce the concentration of risk originating from the loan disbursement and to ease the availability of loans on the different sectors of the economy, the existing fund based limit of 25 % of primary capital and non-fund based limit of 50 % of the primary capital were changed as per the international practice for inspection and supervision as well as the BASEL Core Principles (BCP) adopted by the NRB. Accordingly, a policy of gradually lowering the single borrower limit including the non-fund based to 25 % of the primary capital by 2010 has been adopted. The Budget Speech for 2064/65 has stated that actions against the willful defaulters of banks and financial institutions are to be continued. In coordination with the GON, necessary actions, as per the existing rules, had been taken against the big willful defaulters of more than Rs. 10 million. E-banking directives were issued in 2064/65 in the context of expanding electronic banking in Nepal

3.2 PROMOTING INVESTMENT TO PRIVATE SECTOR

Monetary policy can, perhaps, be more useful in influencing the pattern of investment and production by controlling the provision of credit by banks. It can induce the banks to advance medium-term and long-term loans of productive nature at the same time prohibiting them to advance loans of unproductive and speculative nature. It can also boost up the level of investment by making available savings or resources mobilized by banks for purposes of investment and production. The banks fulfill this task by offering bank credit for investment to business and industry.

Monetary policy has also to ensure that the need for bank credit for investment and production in the private sector are fully met. The banks must provide adequate bank credit to meet at least essential working capital requirements of industry and agriculture. Both large-scale and medium industries require funds for investment in fixed capital, working capital and for maintaining inventories. Subject to appropriate norms fixed for inventory holdings, the credit needs of the private sector should be met if existing capacities in the private sector are to be fully used and also more productive capacity is to be built up. In Nepal, banks have been asked by the NRB to give specific % age of loans at concessional rates of interest to some priority sectors such as agriculture and small and medium enterprises.

FISCAL YEAR 2062/63

The NRB has achieved some success in this regard. In the process, the lending rates of commercial banks have decreased, albeit not sufficient as compared to the past. The credit off-take to the private sector has picked up. The excess liquidity with the commercial banks

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has declined. As a consequence, the profit of the banks has increased. The possible risk to economic growth also requires the continuation of the current soft monetary policy stance. In the light of this, monetary policy aims to facilitate the economic growth of 4.0-4.5 % in FY 2062/63 by channelizing most of the incremental credit to the private sector with only a small portion (10.6 % ) to the government. The banks' credit to private sector is projected to rise by 18.0 % in FY 2062/63 compared to an increase of 17.5 % in FY 2004/05. Increased import credit as well as credit to private sector for infrastructure and consumption purposes provide the basis for the projected growth of claims on private sector in FY 2062/63.

FISCAL YEAR 2063/64

Assuming a significant rise in imports due to the increase in investment by both the private sector and the Government of Nepal, the BOP surplus, which is estimated to remain at Rs. 26.0 billion in 2062/63, has been projected to remain at Rs.16.0 billion in 2063/64. Though the credit to the private sector is not expected to expand rapidly, this bank is of the view that the private sector should use the maximum possible amount of financial resources. In this context, the credit to the private sector is projected to grow by 18.0 % in 2063/64. To develop the risk management system and achieve private sector-led economic growth through the institutional loan flow, establishment of Credit Rating Agency (CRA) in the private sector was encouraged.

FISCAL YEAR 2064/65

The bank has taken the initiative of the private sector for opening the bank and the financial institutions positively. On the external front, a BOP surplus of Rs. 6.87 billion was recorded in the first 10 months of 2063/64 compared to the BOP surplus of Rs. 20.50 billion in the same period of the previous year. Only marginal growth in merchandise export coupled with decelerated growth of private sector’s remittance contributed to the remarkably lower level of BOP surplus compared to the previous year. Private sector remittance inflow, which has become a major source of foreign currency earnings in recent years, increased by 3.9 % in the first 11 months of 2063/64 to Rs. 91.10 billion. In the corresponding period of the previous year, workers' remittance had gone up by 48.4 % . The growth of private sector credit is revised downward to 17.5 % from the initial projection of 18.0 % . Net claims on the GON are estimated to remain within the initial projection. However, the expansion of bank credit to the financial and the nonfinancial government corporations contributed to a higher growth of domestic credit than the initial projection.

3.2 PROMOTE/CONTROL CONSUMPTIONS

Monetary policy can be of great use in these economies for effecting necessary adjustment between the demand for and supply of money. The demand for money is likely to go up on account of increased transactions and gradual disappearance of non-monetized sector

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combined with increased demand for money on account of precautionary and speculative motives. The use of money and credit for speculative purposes has to be controlled by the monetary authorities through suitable monetary policy and by the government through direct physical controls, failing which, inflation is likely to appear, which may stifle growth instead of helping it.

The growth of private sector credit is revised downward to 17.5 % from the initial projection of 18.0 % . Net claims on the GON are estimated to remain within the initial projection. However, the expansion of bank credit to the financial and the nonfinancial government corporations contributed to a higher growth of domestic credit than the initial projection.

FISCAL YEAR 2062/63

Increased import credit as well as credit to private sector for infrastructure and consumption purposes provide the basis for the projected growth of claims on private sector in FY 2062/63. Consumptions in the form deposit have increased and attained growth in the banking sectors. The time deposits of commercial banks are expected to increase by 13.5 % in FY 2062/63 compared to a growth of 12.5 % in FY 2004/05. Based on the assumptions of marginal improvement in GDP growth, increased deposit mobilization of other banks and financial institutions, time deposits of commercial banks is projected to increase only marginally in FY 2062/63 compared to that of last year.

FISCAL YEAR 2063/64

The analysis of the national output from demand side shows that aggregate domestic absorption increased in 2062/63 compared to the previous year. Of the aggregate domestic demand, total consumption expenditure increased, while the growth of total fixed capital expenditure remained low. Time deposits of the commercial banks have increased by 16.5 % on the basis of the increasing trend of the inflow of remittances. This projection was made on the assumption of deposit mobilization by other financial institutions and no major revision in deposit interest rates.

FISCAL YEAR 2064/65

From the perspective of components of M2 and liquidity, the narrow money is estimated to grow by 12.9 % in 2063/64 compared to a growth of 14.0 % in 2062/63. Time deposit with the commercial banks, another component of M2, is estimated to grow by 16.0 % in 2063/64 compared to a growth of 16.4 % in the previous year. The deceleration in time deposit was due to low economic growth, low interest rates and slow down in remittance inflows. Composition of domestic credit of the banking sector has registered some changes in 2063/64. The share of net claims on the GON in domestic credit decreased to 21.2 % in 2063/64 from 22.0 % in the previous year. The share of bank credit to the private sector has, however, increased to 76.1 % of domestic credit in 2063/64 from 75.5 % in the previous year. This can be taken as a positive signal in terms of utilization of bank credit.

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3.3 SUPPORTING ECONOMIC GROWTH

The sectoral impacts of such policy in a developing economy are worth noting. Monetary expansion can be used, at least in theory, to change the terms of trade against the agricultural sector, which tends to benefit from increased production in the secondary or tertiary sectors. If the prices of industrial goods can be raised through inflation without affecting the prices of food-stuffs and raw materials, it may prove useful for growth but in actual practice it may be difficult to follow.

Monetary Policy also boosts economic growth by prioritizing sectors. Priority sector includes agriculture, export and small scale enterprises and weaker section of population. Monetary Policy guides in providing with the help of bank timely and adequately credit at affordable cost of weaker sections and low income groups. Monetary policy helps in employment generation by influencing the rate of investment and allocation of investment among various economic activities of different labor intensities. A high rate of saving promotes investment. Thus, the Monetary Policy helps money management by influencing rates of interest can influence saving mobilization in the country.

FISCAL YEAR 2062/63

The targeted average economic growth rate in the Tenth Plan is between normal 4.3 % to expect 6.2 % . Gross Domestic Product (GDP) at producers' price increased on average by 3.1 % during the first three years of the Tenth Plan. The average GDP growth rate at factor cost remained at 2.7 % during this period. To achieve the minimum targeted economic growth of the Tenth Plan; the GDP at producers price had increased by 6.0 % on average in the remaining two years. Likewise, to attain the expected target of economic growth in the remaining two years of the Tenth Plan, the GDP had also grew by two digits (10.8 % ) on average. Despite higher economic growth rate targeted relative to the previous year level, the growth rate of M2 is targeted at the rate which is slightly above its previous year growth rate so as to avoid the pressure on price level. In FY 2062/63, the growth of narrow money (M1) is projected at 12.0 % compared to the 11.2 % growth in FY 2004/05.

FISCAL YEAR 2063/64

In the Budget Speech of 2062/63, the overall economic growth rate for that year was targeted at 4.5 % . Ensuring overall consistency with the budget statement of the Government, it has been the tradition of the bank to formulate the monetary policy independently. Against this background, with a view to facilitate the economic growth as targeted by the fiscal policy of the Government, in the annual monetary policy statement, the economic growth was projected in the range of 4 to 4.5 % for 2062/63. Such an estimate of economic growth was based on the expectation of normal weather condition leading to good harvest and settlement of political issues resulting in resumption of peace in the country would generate positive impact on the non-agricultural sector. The Nepalese economy was also expected to benefit

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from the high economic growth in the world as well as in the neighbouring countries. The spare capacity of world output has recently decreased. As the high economic growth rate in India, China and Russia has exerted pressure on the price of construction materials, world inflation is likely to rise. As the central banks of the world have adopted tight stance of monetary policy, the impact of such a stance on world inflation will also affect inflation in Nepal.

FISCAL YEAR 2064/65

In the Monetary Policy and the government's Budget Speech of 2063/64, the economic growth of 5.0 % was estimated for that year. The end of internal conflict, improvement in political situation and favourable monsoon were the key bases for that growth projection. As per the recent statistics released by Central Bureau of Statistics (CBS), the real GDP is estimated to have grown by 2.5 % at producers’ prices in 2063/64 compared to a growth of 2.8 % in 2062/63. Monsoon did not remain favourable as expected in the review year. The production of paddy, which contributes 20 % to total agricultural GDP, declined by 12.6 % due to insufficient rainfall, resulting in a fall in food grain production by 4.3 % in 2063/64. This pushed down the growth of agriculture production to 0.7 % in the review year, compared to a growth of 1.1 % in the previous year.

3.4 TRADE PROMOTION

With the growth of imports and exports linkages of Nepal with global economy are getting stronger. While formulating the monetary policy specific industries may be targeted. Improvement is mainly sought by increasing exports both in absolute terms, as well as relative to imports. When specific industries are targeted, trade promotion policies tend to target industries that have a comparative advantage over their foreign competitors. Trade promotion can also include expanding the supply of key inputs in a country's strongest industries, via import expansion. If successful, such a tactic would lead to Pro-trade Biased Growth.

FISCAL YEAR 2062/63

Nepal is experiencing a steadily growing trade concentration with India in the past few years. The share of Nepal’s total trade with India increased to 65.0 % in FY 2004/05 from 54.7 % in FY 2002/03. In the past, Nepal used to pay for the imports of petroleum product in US dollars. In the last few years, such payments are made through the Indian currency. Total merchandise trade flows declined by 0.6 % (Table 19) in the first eleven months of FY 2004/05 as against an increase by 8.2 % in the corresponding period of the pervious year. As a consequence, the share of trade in GDP has declined compared to that of the pervious years. During the first eleven months, trade with India increased by 14.9 % while with other countries declined by 21.1 % .

FISCAL YEAR 2063/64

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The balance of payment (BOP) surplus in 2062/63 is likely to considerably exceed the target set in the annual monetary policy. For 2062/63, BOP surplus was estimated to be at the satisfactory level of Rs.4.5 billion on the expectation of higher growth of imports relative to exports, low inflow of official aid and normal growth in workers' remittances. There is a provision of opening an import LC to import the goods of more than USD 30,000. In addition, there is restriction on payments for goods imported without LC or on imports when actual imports differs from the initial LC and no amendment is made on this LC. This restriction has been withdrawn from 2063/64. From this fiscal year, commercial banks are allowed to amend the LC based on Already Shipped Documents.

FISCAL YEAR 2064/65

The secondary sector grew by 2.2 % in 2063/64 compared to a growth of 4.2 % in 2062/63 on account of unsatisfactory performance of manufacturing and construction sectors. The services sector grew by 4.1 % in 2063/64 compared to a growth of 4.7 % in the previous year. Among the services sectors, the wholesale and retail trade sector declined by 2.6 % whereas transport, communications and storage sector witnessed some improvements in the review year. Likewise, some improvements were also observed in the performance of real estate and business services in the review year. To finance the increasing trade deficit with India, the bank purchased IC by selling the US dollar 920 million (about Rs. 63.88 billion). In 2062/63, the US dollar 600 million was sold to purchase IC. In 2063/64, the bank made a net purchase of US dollar 915.8 million from commercial banks, while it sold US dollar 920 million to purchase IC.

3.5 OBLIGATORY INVESTMENT PORTFOLIO TO BFIS

There exists vast non-monetized sector in under-developed economies which is not responsive to changes in the quantity of money and interest rates and such, this sector remains outside the effective control of the Central Bank. This being the case all out efforts must be made by the monetary authority to extend the sphere of the monetized sector to make monetary policy a success.

For the attainment of the objective of growth with stability, the monetary authority of developing economies, therefore, has to play a positive role in creation, working and expansion of banking and other financial institutions and extend credit facilities where needed. Monetary policy can help in the expansion of financial institutions by granting subsidies and special facilities to new institutions and provision of training facilities for their staff. In most of the underdeveloped countries the credit system is restricted to providing credit for large estates, plantations and to foreign traders, and are not available to farmers, small traders and industries. In such a situation an extension of commercial bank, co-operative bank and savings bank facilities can encourage development and mobilize savings for productive purposes. Therefore, it is said that the creation and mobilization of real savings

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—the most important condition for growth—is helped or hindered by monetary policy and by the development of financial institutions.

FISCAL YEAR 2062/63

Overall BOP remained favorable in FY 2004/05 due mainly to a decline in imports and an increase in inflow of remittances. Due to a surplus in BOP, foreign exchange reserve of the banking sector increased by 6.2 % to Rs. 133.97 billion as at mid-June 2005 (Table 22). Of the total reserves, the share of convertible currencies was 95.0 % and that of inconvertible currency was 5.0 % . An increase in the share of import from India in total trade, import of petroleum products on payment of US dollars and the decline in remittance inflow from India due to an increasing tendency of Nepali working in India to take along their family members have put pressure on Indian currency reserve. NFA (adjusting the foreign exchange valuation) of the banking system, an expansionary factor of money supply, increased by 7.0 % (Rs. 7.65 billion) during the first eleven months of FY 2004/05, compared to a much higher growth of 14.5 % in the same period of the previous year. Slowdown in foreign loans led to a lower growth in NFA in the review period compared to that of the previous year.

FISCAL YEAR 2063/64

Monetary liquidity expanded in 2062/63. The commercial banks also had a significant level of excess liquidity. A part of the excess cash liquidity of commercial banks was mopped up through the fresh issue of government securities amounting to Rs.11.9 billion as stated in the budget speech for 2062/63. In addition to this, the NRB sold treasury bills worth Rs.13.5 billion through outright sales auctions mopping up further excess cash liquidity from the banking sector. For mopping up short-term excess liquidity, the bank also undertook the reverse repo auction of Rs.6.5 billion. In terms of absolute amount, the amount of nonperforming loan stood at Rs.29.0 billion as of mid- April 2006. Thus, maintaining financial sector stability is still a daunting task for Nepal. The mounting level of NPL of problem banks, RBB at 50.9 % and NBL at 43.4 % , has resulted in a higher aggregate NPL level in Nepal's banking system.

FISCAL YEAR 2064/65

Of the sources of M2, net foreign assets (NFA) of the banking sector (adjusting exchange valuation gain/loss) is estimated to grow by Rs 7 billion compared to the initial projection of Rs 16 billion in the Monetary Policy of 2063/64. The NFA had increased by Rs 25.70 billion in 2062/63. The slowdown in the growth of merchandise exports, deceleration in the growth of private remittance from abroad and the increase in payment of NOC to the Indian Oil Corporation were the major reasons for the deceleration in NFA in 2063/64 compared to that of the previous year. Composition of domestic credit of the banking sector has registered some changes in 2063/64. The share of net claims on the GON in domestic credit decreased

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to 21.2 % in 2063/64 from 22.0 % in the previous year. The share of bank credit to the private sector has, however, increased to 76.1 % of domestic credit in 2063/64 from 75.5 % in the previous year.

3.6 POLICIES TO MAINTAINING FINANCIAL STABILITY (INTERNAL AND EXTERNAL)

Financial stability means the ability of the economy to absorb shocks and maintain confidence in financial system. Threats to financial stability can come from internal and external shocks. Such shocks can destabilize the country’s financial system. Thus, greater importance is being given to the policy role in maintaining confidence in financial system through proper regulation and controls, without sacrificing the objective of growth.

Monetary policy is an important instrument for achieving financial stability. It brings a proper adjustment between the demand for and supply of money. An imbalance between the two will be reflected in the price level. A shortage of money supply will retard growth while an excess of it will lead to inflation. As the economy develops, the demand for money increases due to the gradual monetization of the non-monetized sector, and the increase in agricultural and industrial production. These will lead to increase in the demand for transactions and speculative motives. So the monetary authority will have to raise the money supply more than proportionate to the demand for money in order to avoid inflation. Monetary policy should try to maintain in the economy a most suitable interest rate structure. At present the interest structure is amendable only in the upward direction and very little in the downward direction, but with the help of monetary policy the structure becomes somewhat manageable in the downward direction also.

FISCAL YEAR 2062/63

The economic and monetary situation of FY 2004/05, the prevailing situation in financial sector, necessity for a gradual relaxation in external sector and expected performance of domestic and external economies in FY 2062/63 are the bases for the formulation of monetary policy for FY 2062/63. Like in the past, the pegged exchange rate regime of Nepali Rupee vis-à-vis Indian Rupee is taken as a nominal anchor. The NRB is also of the view that the successful completion of restructuring of the problematic banks and bringing these banks back to the normal position requires a medium term period of 4-5 years. In the light of this fact, while extending the management contracts of NBL, the cost of management contract was reduced by 20 % from the proposed US $ 3.5 million to US $ 2.78 million. This was mentioned in the mid-term review of monetary policy of FY 2004/05, which was made public on February 16, 2005. Similarly, with regard to RBB, the cost of contract for 4 foreign consultants and 18 Nepali consultants has been reduced to US $ 0.727 million and Rs. 60 million respectively while extending the contract period for one year.

FISCAL YEAR 2063/64

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Under the financial sector reform initiated in the recent past, re-engineering of NRB, restructuring of NBL and RBB, and the capacity building of the financial sector will continue to be effectively implemented in 2063/64. 76. The bank has prepared the first five-year strategic plan so as to effectively implement the functions assigned in the NRB Act 2002. These plans will be gradually implemented from the beginning of 2063/64. Accordingly, a necessary monitoring and evaluation framework will be introduced in order to carry out the activities of the bank as specified by the strategic plan. In the context of Nepal's WTO membership, for allowing foreign banks' branches to enter in wholesale lending, a preliminary report has been prepared. Necessary work will be done to implement this report. The mounting level of NPL of problem banks, RBB at 50.9 % and NBL at 43.4 % , has resulted in a higher aggregate NPL level in Nepal's banking system. This bank has also taken serious note of the high growth of NPL in some private sector commercial banks.

FISCAL YEAR 2064/65

To improve the financial situation of the two government owned banks, NBL and RBB, by restructuring them, the management of these banks was handed over to the foreign consultants. The cost incurred under financial sector reform amounted to Rs 2.44 billion for NBL including Rs 813.2 million for the consultants' fees and Rs 1.62 billion for the voluntary retirement scheme till mid-March 2007. Similarly, for the RBB, the total expenditure stood at Rs 2.69 billion including consultants' fee of Rs 428.7 million and voluntary retirement cost of Rs 2.27 billion. The cost for the mechanization in the NBL and RBB stood at Rs 141.3 million, and the cost of reengineering of the NRB was Rs 253.5 million. In this way, a total of Rs 5.53 billion was spent for financial sector reform till mid-March 2007.

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CHAPTER - IV: GROUP REMARK

4.1 GROUP REMARK ON MONETARY FUNCTION

A well-structured monetary policy can contribute to the fulfillments of the objectives such as full employment, stable price, favorable balance of payment and economic growth. Nepalese monetary policies introduced in the past have been successful to some extent to drive the economy on the right track curbing inflation, injecting needed money for the economy and thereby maintaining BOP position comfortable. Monetary policy has properly managed the adjustment between money demand and supply.

NRB Act 2058 paved the way to formulate sound comprehensive monetary policy and strategies by Nepal Rastra Bank. Consequently, NRB has introduced monetary policies since the fiscal year 2059/60. Due to the implementation and favorable impact of such monetary policies and strategies, progress has been witnessed on the process of financial deepening in the economy. Before liberalization, Nepal Rastra Bank followed direct monetary instruments such as interest rate, margin rate, statutory reserve requirements (SLR), and so on. However, after economic liberalization, indirect instruments such as cash reserve ratio, open market operation and bank rate have been used. Like other policies, the primary objectives of monetary policy to attain the macroeconomic goal or objectives such as stability, growth, full employment, favorable balance of payment and so on. Before the liberalization of 1990s, Nepal Rastra Bank followed direct monetary instruments such as interest rate, margin rate, statutory reserve requirements (SLR), and so on. However, after economic liberalization, it started using the indirect instruments such as cash reserve ratio, open market operation and bank rate.

4.2 GROUP REMARK ON DEVELOPMENT FUNCTION

The monetary policy in a developing economy will have to be quite different from that of a developed economy mainly due to different economic conditions and requirements of the two types of economies. A developed country may adopt full employment or price stabilization or exchange stability as a goal of the monetary policy.

The differences between developing and under developing country can be reflected in economic growth as primary and basic necessity. Thus, the monetary policy can play a significant role in accelerating economic development by influencing the supply and uses of credit, controlling inflation, and maintaining balance of payment. The monetary authority of a developing economy should play a vital role by adopting such a monetary policy which creates conditions necessary for rapid economic growth. Once development gains momentum, effective monetary policy can help in meeting the requirements of expanding trade and population by providing elastic supply of credit.

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Thus, one can draw the conclusion that Nepalese monetary policies introduced in the past have been successful to some extent to drive the economy on the right track curbing inflation, injecting needed money for the economy and thereby maintaining BOP position comfortable. The monetization of a broader range of economic activities and transaction would facilitate financial savings, as would the broadening of the range of flexible saving instruments–all key elements in the process of financial deepening, which is often measured by the rate of broad money to GDP. With more financial deepening enabling households to better smooth their consumption which in turn feeds back to a more stable real economy.

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REFERENCES

http://www.nepalstock.com/

https://books.google.com.np/books?id=CvDfftPyfDoC&pg=PA72&lp

https://nrb.org.np/ofg/monetary_policy/Monetary_Policy_(in_English)--2005-06.pdf

https://nrb.org.np/ofg/monetary_policy/Monetary_Policy_(in_English)--2006-07_(Full__Text).pdf

https://nrb.org.np/ofg/monetary_policy/Monetary_Policy_(in_English)--2007-08_Report.pdf

https://nrb.org.np/ofg/policy.php?tp=monetary_policy&&vw=15

https://nrb.org.np/red/publications/annual_reports/in_English--2005-06.pdf



https://www.nepjol.info/index.php/EJON/article/view/160

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https://www.nepjol.info/index.php/EJON/article/view/160




https://nrb.org.np/ofg/policy.php?tp=monetary_policy&&vw=15

https://nrb.org.np/ofg/monetary_policy/Monetary_Policy_(in_English)--2007-08_Report.pdf



https://nrb.org.np/ofg/monetary_policy/Monetary_Policy_(in_English)--2005-06.pdf

https://books.google.com.np/books?id=CvDfftPyfDoC&pg=PA72&lp

http://www.nepalstock.com/