Has NRB put BoP stability on back burner?

Published On: August 4, 2019 09:15 AM NPT By: Sagar Ghimire  | @sagarghi

Expansionary monetary policy likely to build pressure on external sector

KATHMANDU, Aug 4: The country's external sector position is likely to worsen in the current fiscal year 2019/20 as Nepal Rastra Bank (NRB) has focused on supporting the government's growth target rather than the stability of price and balance of payment (BoP).

At a time when the BoP has slipped into deficit, the central bank's expansionary monetary policy introduced for the current fiscal year is likely to further exacerbate the problem, warn experts.

Lowering the target for foreign exchange, cutting the policy rates, and increasing private sector credit growth target are some of the key examples of the expansionary stance of the monetary policy.

Experts say that the central bank should have tightened the monetary policy at a time when the economy has been growing by over six percent annually for last three years after a prolonged period of tepid growth. The economic expansion above the historical average has also put a substantial pressure on the domestic economy and the current account.

Instead of addressing the challenges that the growth could put on the external sector stability through the monetary policy, the central bank opted for measures which will further compound the risks.

“Whenever Nepal faced a BoP deficit, NRB adopted a tighter monetary policy stance in the past,” said Nara Bahadur Thapa, a former executive director of the central bank. “However, the current monetary policy stance has been exceptional, making a historic departure in its choice of growth objective in the face of a large size of BoP deficit,” added Thapa, who had also headed the Research Department of the NRB.

According to the data of the NRB, Nepal had faced the problem of BoP deficits seven times after the establishment of the central bank in 1956. The country had to approach the International Monetary Fund (IMF) three times to address the BoP problem.

Against the expectations that the NRB will tighten its monetary policy to limit the buildup of financial sector and external sector risks, the central bank came up with a too accommodative monetary policy.

According to the data of the NRB, the BoP slipped into a deficit of Rs 90.83 billion in the first eleven months of the last fiscal year 2018/19 compared to a deficit of Rs 4.34 billion in the same period of the previous year.

The monetary policy also comes against the recommendation of a tighter policy by the IMF.

“To manage fiscal and external-sector pressures and promote a more durable economic expansion, the IMF team's assessment is that a measured tightening of policies is warranted — higher interest rates, tighter macroprudential policies, and a smaller fiscal deficit than currently budgeted would be more suited to the current economic circumstances,” read the report of the IMF 2018 Article IV Mission to Nepal.

“These adjustments would reduce pressure on the current account by constraining import growth and foster a pace of expansion more consistent with the economy's current domestic productive capacity. Measured adjustments to policies today could pay dividends in terms of more stable and higher future growth,” it added.

The central bank, too, has admitted that the external sector will face pressure in the current fiscal year. It has projected that the foreign exchange reserve will be adequate to finance the imports of commodities and services of seven months in the current fiscal year, down from the projection of eight months in the last fiscal year 2018/19.

However, NRB officials say that the central bank has not put its key objective of BoP stability on the back-burner. “The target of the forex reserve is not something to worry of. It's still a comfortable position. We have made several provisions that will help to increase our cushion of foreign exchange and improve the external sector position,” said Gunakar Bhatta, the chief of the Research Department at the NRB.

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