Rates to remain high as money supply growth slows

May 29, 2017

The Kathmandu Post, 28th May 2017, Kathmandu

Interest rates are unlikely to come down anytime soon as the Nepal Rastra Bank has revised its money supply growth rate downwards to 16 percent for the current fiscal year. This may hit economic growth in the next fiscal year, as higher rates, particularly lending rates, tend to work as a disincentive for the private sector to expand operations or open new businesses.

The central bank had forecast money supply growth rate of 17 percent for the current fiscal year. As of the third quarter of this fiscal year ended mid-April, year-on-year growth rate of money supply stood at 16.2 percent.

This growth rate, however, is likely to come down to 16 percent by the end of this fiscal year, says the third-quarter monetary policy review report of the NRB. The growth rate is expected to come down on the back of moderation in inflation, deceleration in growth rate of net foreign asset and policies introduced by the central bank to discourage banks and financial institutions from rapidly extending credit to the private sector, the report says.

Inflation moderated to an average of 5 percent in the first nine months of the current fiscal year--as against 9.9 percent in the last fiscal year—driven by normalisation in supply situation. Growth rate of net foreign asset, on the other hand, fell to 5.3 percent in the first nine months of the current fiscal year, as against 21.9 percent recorded in the same period because of slowdown in remittance growth and soaring imports. 

Similarly, the NRB has reduced the threshold for personal overdraft to Rs7.5 million from Rs10 million, and barred banks and financial institutions from extending more than 50 percent of the value of the vehicle as credit to auto loan seekers. These measures were taken to reduce the flow of credit towards unproductive sector.

“All these factors have reduced money supply growth rate. This, in turn, is expected to keep interest rates at higher level in the coming days,” Nara Bahadur Thapa, head of the Research Department at the NRB, said.

Average deposit rate stood at 5.1 percent in mid-April as against 3.3 percent in mid-July when the fiscal year 2016-17 began. This is good news for those who park money at banks and financial institutions. 

But higher deposit rates push up credit rates as well, which may not be good news for borrowers looking forward to expanding their operations or starting new ventures. Average lending rate stood at 10.8 percent in mid-April as against 8.9 percent in mid-July. “The hike in credit rates, however, will prevent excess flow of credit towards unproductive sectors, while rise in deposit rates will inculcate savings habit and help push up gross domestic savings,” the report says.

Gross domestic savings have historically remained low, which prevents capital formation. In the current fiscal year, for instance, gross domestic savings is expected to remain at 10.25 percent gross domestic product (GDP). This indicates almost 90 percent of the GDP is spent in consumption.

Despite low gross domestic savings, the country’s gross national savings is expected to hover around almost 44 percent of the GDP in the current fiscal year, which is one of the highest in the world. This is largely because of inflow of remittance and foreign grants. If this resource is efficiently utilised, the country can easily bridge the huge infrastructure gap, which will spur economic growth.

“Also, public spending, especially capital spending, needs to go up, so that physical infrastructure required to attain high growth rate could be built,” Thapa said. “This will ultimately attract private investment as higher public spending crowds in private investment.”

The government’s inability to utilise capital budget has raised government’s savings to over Rs260 billion.