Costs and benefits of monetary policy changes

By Nara Bahadur Thapa

The Nepal Rastra Bank (NRB) has effected changes in two of its monetary policy instruments with effect from December 20, 2001. According to the new changes, both refinance rates and the minimum cash requirement/ratio (CRR) were revised downward. Refinance rates were reduced by 100 basis points to (one basis point being one hundredth of a percent) 200 basis points. Currently, there are four refinance facilities with four corresponding refinance rates. These are (i) refinance against foreign currency export loans, (ii) refinance to financial institutions against their sick industry loans, (iii) refinance for rural development banks and export loans in local currency and (iv) refinance against all other loans. The refinance rate against foreign currency export loans has been reduced by 200 basis points to 2.0 percent from 4.0 percent, refinance rate for sick industry loans by 150 basis points to 3.0 percent from 4.5 percent, refinance rate for Rural Development Banks and export loans in local currency by 100 basis points to 4.5 percent from 5.5 percent and refinance against all other loans by 100 basis points to 5.5 percent from 6.5 percent.

Similarly, the CRR has also been cut. The minimum CRR with respect to domestic current deposits and domestic savings deposits to be maintained with NRB has been reduced by 100 basis points to 7.0 percent from 8.0 percent. Likewise, the minimum CRR with respect to domestic fixed deposits to be maintained with NRB has been trimmed by 150 basis points to 4.5 percent from 6.0 percent. The weighted minimum CRR to be maintained with NRB has thus been reduced to 6.0 percent from 7.0 percent. However, the minimum CRR of total domestic deposit liabilities to be maintained in commercial bank vaults has been kept unchanged at 3.0 percent. The average minimum CRR both with NRB and in commercial bank vaults has been reduced by 100 basis points to 9.0 percent from 10.0 percent.

The accommodative monetary policy stance has been taken with a view of minimising the current adverse economic situation facing the country. The current status of economic activities is best approximated by the GDP growth rate forecast of 2.5 percent for the current fiscal year 2001/02, the lowest since 1987. The projected economic growth rate of 2.5 percent has decelerated from 4.95 percent in 2000/01 and 6.4 percent in 1999/00. The gloomy projection of GDP has been based on the unsatisfactory performance of exports, tourism, industries and the agricultural sector. The available data so far shows that merchandise exports have fallen by 8.3 percent in the current year as against an increase of 42.3 percent in the corresponding period of the previous year. The compression in overall exports has been attributed to the continuous decline in carpet and garments, the top two convertible exchange earners. Pashmina export has also been witnessing a decline in recent times. The global economic recession and the internal situation of the country have been the major factors responsible for the decline of Nepalese exports to overseas markets. The delay and uncertainty in the renewal of the Nepal–India trade and transit treaty have also adversely affected Nepalese exports to India. Additionally, factors such as the internal security problem, the September 11 incidents in the USA and the fallout of the Indian plane hijacking that took place two years before, have all contributed to the decline of the Nepalese tourist sector.

Monetary growth has also decelerated in recent times. For example, broad money growth, which had increased by 21.8 percent in 1999/00, decelerated to 15.2 percent in 2000/01. The monetary expansion is likely to decelerate further during the current fiscal year. The bank credit to the private sector has likewise shown a similar trend of deceleration to 15.8 percent in 2000/01 from 20.8 percent in the preceding year. On top of this, the free reserves of commercial banks have also gone down in recent months. These indicators suggest that there is a growing need to augment the liquidity situation in the system. It is with a view to ameliorating the overall situation that NRB responded with a cut in both the CRR and refinance rates. The present cut in CRR will release the lendable resources of commercial banks to the tune of Rs 1.92 billion. The monetary policy changes have also take the global context into account. The Indian monetary policy regime has been made liberal in recent times. Since Nepal has an open border with India coupled with unlimited convertibility of NC into IC, it is not prudent to keep the Nepalese monetary policy regime markedly different from the Indian policy regime. Additionally, the international monetary policy regime has also been made easy in recent times. Central bank discount rates and money market interest rates have come down drastically. Against the background of all these factors, a need was felt for suitable changes in monetary policy.

There are both costs and benefits associated with the monetary policy changes. The major concerns of policy changes are the likely adverse effects on inflation and on the balance of payments situation. Inflation so far has been tolerable. In 2000/01, the inflation rate measured by changes in the national urban consumer price index was 2.4 percent. The price situation so far suggests that prices will not go up more than 5.0 percent in the current fiscal year, which is within the tolerable limit from developing countries’ perspective. The current monetary policy changes are not expected to aggravate the price situation further. The improved price situation in India is also expected to generate a salutary impact on prices in Nepal. The balance of payments (BOP) is another front where a loose monetary policy stance is said to create an adverse impact. In this context, it is important to take note that Nepal had a reasonable level of BOP surplus of Rs 5.2 billion in 2000/01. However, the current situation in merchandise export and the tourist sector does not portend well for BOP. Therefore, it is feared that the current easy monetary policy stance will further aggravate the country’s BOP situation.

But, two factors are to be taken into account before reaching this conclusion. First, the monetary approach to balance of payments suggests that domestic credit expansion leads to one to one depletion of the international reserves of the country. The argument is that the cut in CRR will only lead to a depletion of international reserves in Nepal. Hence, the CRR cut is not desirable. But we have to remember the amount of loanable resources of commercial banks that are being released due to the CRR cut. The amount is Rs 1.9 billion, which is less than 1 percent of domestic credit of the monetary sector. This suggests that the reserves loss will not be significant. Besides, the monetary approach to balance of payments is based on an assumption of full employment of resources, which is not the case in Nepal. This means that some additional local reserves released from the CRR cut will be absorbed in domestic production. Second, even if there is an international reserves loss from the CRR cut, it will not put much pressure viewed from the fact that Nepal has international reserves sufficient to cover about 11 months’ merchandise imports. After all, there has to be a productive use of international reserves. Moreover, the cut in refinance rate in general and the cut in refinance rate for convertible currency export loans for the import of raw-materials and machinery for export oriented industries in particular are expected to enhance international reserves.

Capital flight is another concern raised against the easy monetary policy stance. But the point is that the cut in CRR reduces the financial cost of commercial banks, thus enabling them to pay relatively higher interest rates on deposits and charge lower interest rates on loans. It is clear that the cut in CRR prevents capital flight out of the country and also helps attract foreign capital into the country. This may be a weak argument but it is true. Another concern is that the additional reserves that will be released from the CRR cut will enable commercial banks to hold more government securities at the cost of NRB and thus facilitate the transfer of profit from NRB to commercial banks. This situation will only arise if commercial banks invest their additional reserves in government securities instead of increasing lending to the private sector. Fine, even if this happens. But we must take note of the fact that reduction of government debt stock is required as per the new NRB Act 2001, which ties the government debt stock with the previous year’s government revenue. On top of this, if the policy changes help improve the financial health of commercial banks, it will be good because effective monetary management depends on the state of financial position of commercial banks.

The following are the benefits of monetary policy changes. First, with the reduction in both refinance rates and CRR, the export sector is likely to benefit. This will help relieve the problems of the export sector to some extent. Second, sick industries will also benefit as the refinance rate against such loans has been reduced by 150 basis points. Under this arrangement, production as well as employment opportunities will increase. Third, the cut in CRR will release Rs 1.92 billion in loanable funds of commercial banks. If this is channelised into productive investment, it will lead to an increase in economic activities. Fourth, the cut in CRR will help commercial banks lower the interest spread, which in turn helps reduce financial intermediation costs. Fifth, a higher CRR is a tax on financial intermediation. Reduction in CRR is considered to be one additional step towards the ongoing financial sector reforms. This will help expand financial intermediation in the country. In the process, both depositors as well as borrowers are expected to benefit from the monetary policy changes.

To sum up, both refinance rates and CRR are indirect monetary policy instruments. Monetary authorities cannot directly force banks and financial institutions to behave as per these policy changes. The desired impact of these policy changes depends on the behaviour of banks and financial institutions, on the extent to which they align their behaviour to the policy changes. It is expected that exporters, sick industrial units and banks will take advantage of these policy changes. In this will lie the effectiveness of policy changes in increasing real output and employment opportunities. This is a good gesture of the monetary authorities taken at a time of slowdown in economic activities. This gesture taken in a time of need has certainly heightened the moral authority of NRB, and will enhance the future effective use of moral suasion as a monetary policy instrument.

(The author is Deputy Director of Nepal Rastra Bank)

Is peace only a dream ?

By Sarita Bahety

The lad saw an unwary butterfly perched onto the wall. He leapt towards it and in another moment he picked it up by pinching it’s colourful tiny wings and lo, he killed the harmless insect just for fun. I was literally taken a back at such a horrific deed of a chit of a boy and wondered what pleasure did he derive by doing so. In the wake of the tragedy inflicted in this world, the loss of human lives due to terrorism is shocking. The heart-rending series of destruction goes to prove that even the lives of humans is perhaps being treated at par with those of insects. The difference is, now the tiny boy is replaced by a gang of desperados who having avenged themselves rejoice the success of their well-orchestrated plans of devastation. One of the worst tragedies in America, perpetrated by fanatics who are utterly indifferent to the sanctity of the human life is indeed a shame on humanity.

Lives of innocuous mortals who have nothing to do with the terrorists is in danger. Thousands of people are killed like insects, as if their lives had no value. It is an open challenge to the very existence of human civilisation itself. The ego clash of men and the lust of power is enough to cause an irreparable destruction. Innumerable people have lost their near and dear ones in this horrific sequence of destruction. Can any one in this world bring them back to life? The answer is an emphatic no. I fail to understand as to what crime those innocent people had committed that they have to bear the brunt of the audacious terrorists at the cost of their lives. God has bestowed intelligence upon the human beings so that we can judiciously use the natural resources and live with the fellow beings in a cordial harmony. He hasn’t created the beings to be drowned in the pool of each others’ gore. Now the slogans of world peace seem to be enveloped by the dark clouds of angst and fear that may lead to war like situation.

In schools we are taught about the moral values of life. We are tutored to be kind to everyone and to seek the blessings of almighty. As we are growing and making more advances in science and technology, the human life is become a puppet whose strings are in its hands. Advances are meant to make our life comfortable and not to bring an end to it. The utter misuse of science by destructive brains has actually led to a cruel death of humanity and a sense of insecurity and fear has developed among all. It seems as if the feelings of love and care have been swept away by selfishness and harrowing brain waves. In the cloak of human skin now there exists a vampire, thirsty for gore. The moral ethics have been totally wiped out of the brains and hearts. Now the rows between individuals, the rivalry between countries have assumed alarming proportion and have become a threat to the entire civilization. The so-called safest place in the world has become a victim of the wrath and revenge of a handful of outrageous individuals. The question remains unanswered: "Where are we heading to – another world war?"

Cost of terrorism for democracy

By Dr Shreedhar Gautam

America may feel victorious in its fight against terrorism in Afghanistan, but the Taliban also has succeeded in making America’s open society rather closed and more vulnerable. Americans can no longer enjoy their civil rights as freely as before in the aftermath of September 11. Americans did not have the remotest fear that the Taliban and Osama bin Laden whom they invented through the Mujahideen would pose a serious threat to their own country. Though the cruel acts of September 11 have provided America a heaven sent excuse for subjugating all other countries with a view to establishing its universal supremacy at all times and under all conditions, America’s leaders realise that they have gotten this at the cost of civil liberties at home.

It will be an error to believe that America has been vociferously pursuing its policy of supremacy towards the rest of the world only after September 11. A sense of American supremacy has been at the core of every prescription pertaining to democracy, human rights, peace, security, disarmament, minority rights, environment, labour standards, women’s empowerment and child labour since after the Second World War in general and the dissolution of the Soviet Union in particular. Despite full knowledge that the principles espoused by America are guided by selfish design, people in large parts of the world accepted them as a means of popular struggle to wrest power from tyrannical regimes.

Our fight against the Panchayat system 12 years ago was also guided by and benefited from western values, though we know that the west supported the ‘people’s movement’ keeping in mind the positive outcomes for themselves in the aftermath of the struggle. But the tragic events of September 11 have brought about a sea change in the concept of democracy itself. Now the open and democratic system itself has been perceived as the biggest threat to civil societies. It is exactly for this reason that America is not asking General Musharraf to hold democratic elections in Pakistan.

As long as Musharraf serves the interests of America, he will be treated as a vital partner in South Asia. America does not mind even if India and Pakistan resort to state repression in some parts of their countries, as long as they support the American line of action in world affairs. The American war against terrorism in Afghanistan has brought many radical changes in the mind set of rulers in South Asia. Now Indian leaders are trying to pass the controversial POTO Bill through parliament taking advantage of the American pursuit of terrorists in Afghanistan. Our own government too seems very much confident in its fight against Maoists activists in the present context created by September 11. Against this backdrop any question against government action could be viewed as unpatriotic.

Terrorism everywhere in the world is proving to be too costly for democratic space. In normal circumstances the Indian government would not have dared to push through draconian laws and provisions in the name of safeguarding democracy, but the American war against terrorism and the recent terrorist attack on the Indian Parliament have changed the situation drastically in favour of the government. America and Britain themselves, supposed to be citadels of democracy, are feeling more and more uncomfortable living with democracy as they find it too obstructive in the path of dealing with unwanted elements.

India’s BJP leaders, who had the bitter experience of being detained under emergency law in 1975, are now vehemently defending the provisions of POTO because they know that the western world will no longer raise any hue and cry against such laws. It is a great pity that these days America, Britain and India are invariably legitimizing controversial rules citing civilized norms such as peace and democracy. America and Britain are adopting laws for detaining foreigners suspected of terrorism without trial in civil court. Moreover, with the UN lending sanction to war in the name of self defence through its resolution 1373 (2000), member countries feel free to adopt harsh measures in the name of fighting terrorism. Very few have pondered that this resolution could be taken as an excuse to deny genuine human rights.

Kofi Annan, who has been awarded the Nobel peace prize, has himself opined that sovereignty of a country cannot be taken as an excuse in the fight against terrorism. His remarks reveal that human rights and democracy have moved a long way after Sept 11. This development could encourage many dictators and would be dictators in the world because they will have the excuse of terrorism against any outrage at their action.

Now the USA cannot criticise General Musharraf or any other general because it has militarized its own system by enacting a law for trying non-US citizens by military tribunal, not civilian court. It is surprising that in the aftermath of September 11, more and more democratic countries are adopting anti-terrorism laws, which suggests that more terrorist groups are emerging in democracies than in non-democracies.

Apart from America, Britain, Canada, Japan and India, about fifteen European countries are going to introduce severe anti-terrorism laws in addition to the exiting ones. It is to be noted that not long ago these European countries were staunch critics of harsh measures adopted by other countries, including Britain. That these countries are going to adopt stern anti-terrorist provisions simply shows the changed context and also how terrorist activities are taken as the factor responsible for curtailing the basic rights of ordinary citizens.

Though the danger from terrorists cannot be minimized in any part of the globe, anti-terrorism laws can never be absolute in themselves. It should be seen that adequate safeguards are taken against state terrorism in any form in the name of national security. Moreover, the countries fighting against terrorism should not be over zealous in their fight. America should also realise that the elimination of Osama bin Laden or the overthrow of Saddam Hussein will not end terror everywhere in the word. There is no reason for non-US citizens to be overwhelmed over the America action because the post September 11 laws are directed at aliens, who could be wrongly accused and denied due process in the US. There seems no immediate sign of an end to American action against terrorism with the US decision now to expand the fight to other countries like Iraq and Sudan. It is time for all to ponder once again over the cause of terrorism in their respective countries.

America should also realize that it cannot live in peace hereafter if it does not mend its ways. It has to change its biased role in the Middle East and partisan altitude to the Iraqi people. Similarly, other countries too need serious introspection over the emergence of terrorism and take genuine remedial socio-economic measures. Otherwise, more and more open societies will be turned into medieval societies. For America too this is a serious matter because the founders of that country had never wanted their people to live in a state of perpetual fear and uncertainty. If America’s leaders become large hearted, and revive the good old days, the rest of the world will follow suit not because of America’s superpower status, but for its magnanimity and generous attitude to other countries.