Where is the Interest Rate Heading to?

by Resta Jha

For a market to become perfect, there are three important components. First is 'market determination of interest rate', second is 'market determination of interest rate', and the third is 'market determination of interest rate."

I remember the above statement, included in a speech delivered by one of the renowned IMF residents in Colombo way back in 1999. With so much stress on free-flowing interest rates, it was clearly evident that the speaker was a strong advocate of a market driven interest rate system. There is no second opinion regarding the above statement and it is a fact that market conditions, viz. demand and supply of funds, must drive the interest rates. Is it happening in our economy?

Nepali market has witnessed high and low interest rate regimes. The benchmark interest rate (91-Day Treasury Bill rate) was as high as 12% at one point in time and as low as 0.75% in another. Does this mean, that Nepali market is a perfect market as far as interest rate movements are concerned?

Large interest rate movements alone, as observed in our economy, do not qualify the market to be called a perfectly interest rate-driven economy. It depends on how interest rates moved over the time. One of the senior economists of the country once said, "The rules of economics do not apply in this economy ". His words are justified by the fact that interest rate movements in our economy do not have any relationship with the prevailing inflation, money supply or savings at any given point of time. However, with the increase in the number of financial institutions, the market started moving from being a seller's market towards a buyer's market, which resulted in declining lending rates. Technically, among other things, lending rates are supposed to indicate the risk profile, which in turn is a reflection of the state of the economy and therefore a precursor to how capable a business is to generate sufficient cash flows to meet its obligations. If this phenomenon were to hold true in Nepal, the lending rates should have moved upward. A prudent banker would always make an attempt to price its products according to risk. But ironically, lending rates in Nepal softened drastically even when the economy witnessed a negative growth. The only market force that has come into play here is the intense competition among the providers of financial services.

There are number of factors playing their roles for this illogical movement of interest rates. First, the behavior of market players. A classic example in this regard would be accepting a 5-year deposit at the rate of 13% by a financial institution and lending the same funds at the rate of 16% for first year, at 14% in the second year, at 12% in the third year, at 9% in the fourth year and at 7.5% in the fifth year. This is a case of clear-cut loss deal for the financial institution arising due to mismatch of the maturities in assets and liabilities. It is also a typical example of interest rate re-investment risk arising due to maturity mismatch through creation of an asset for 1 year with a 5-Year liability. This poor Asset and Liability Management (ALM) within the financial institutions has prompted many failures (and also close downs) of business by some finance companies. It must be loud and clear to these market players that longer period does not mean higher interest rates. It is a question of an opportunity to invest the funds at a higher rate while the deposit for the similar period is available at lower rate.

Irrational behavior of the savers is another reason for the imperfectness in the prevailing deposit interest rates in the market. Interest rate has two components - the risk free rate plus the risk premium. In general, the depositors or savers in the Nepali market are not interest rate-sensitive neither do they consider the risk factor while depositing their funds. Two banks of the same market are providing 2.5% and 5.5% in their respective saving deposits. A chunk of depositors are maintaining their accounts with the bank providing lower interest rates, not because of risk and return perception, but  because of being driven by not-so-important non financial factors. Another segment of depositors is happily maintaining their deposits with the banks declared technically insolvent by an international auditing firm. This is another example of irrational behavior of the savers in the country.

Interest rates of government securities, which are regarded as benchmark rates, are not allowed to move freely as per the market demand, thanks to the unique Public Debt management style of the Central Bank. For example, suppose there is a float of NPR 1 Billion during a week and there have been two bids - one of NPR 500 million at 5.5% and the other of NPR 500 million at 6.0%. If we go by the market demand, the interest rate on this government security should be allowed to move upto 6% and entire security of NPR 1 billion has to be sold through primary window. However, in reality, the case is different. Nepal Rastra Bank normally puts a cap and curbs the interest rate (for example to 5.5% in this case) and sells only NPR 500 million through primary window and remaining government securities worth NPR 500 million gets sold through the secondary window. This is a very good example of direct intervention in curbing the interest rate.

If we are to move towards market determination of interest rates, all the players including savers, financial institutions and regulators have to demonstrate a professional behavior while taking their financing and investment decisions.

(The writer is "Head of Finance and Treasury" at Laxmi Bank Ltd.)

Ads of the Month

Simplicity is virtue

In this column a couple of months back (July 2003), we had criticised Nepal Lever Ltd. (NLL) for using foreign ads for its products marketed in Nepal. Our argument was that this practice does not help the advertisement industry to grow in Nepal. The point was that NLL's principal Hindustan Lever Ltd. is regarded as the University Advertisement and similar role is expected in Nepal from NLL. For this the company should run ads created in Nepal with Nepali models and Nepali technicians. It seems NLL heard the plea and now it has started advertising White Lux with Jharna Bajracharya, a Nepali film actress, as the model.

So far so good. But what about the quality of the ad with Jharna as the model? "International class", said the members of the panel of experts for this column. The model, the design as well as the placement - everything is the best. Also the photography by ace Nepali commercial photographer Madhav Thapa is rated the best. The minimal copy, high credibility and good aspirational factor for the middle class are the other ingredients admired in it.

However it is strange that despite it being such a good ad, the agency that created it - Thompson Nepal - has not claimed the credit for the same. The customary name of the agency at the corner of the ad in fine print is missing on this ad.

NLL's another current ad, that offers a plastic jar free for every purchase of Active Wheel packet priced Rs. 40, was not fortunate enough to get similar praise from the panelists. One comment was that the entire elephant would have been better than only one leg of an elephant. Another weakness pointed out was that the message that says "also available in Rs. 3 pouches" clashes with the main message.

One interesting ad of the month was that for Subidha, a newly launched home delivery shopping service. The panel members rated it good to look at and thus attractive but they also said it is not complete. The ad does not mention the facilities or the types of the products that are available under it. If the prospect who would phone at the number mentioned finds out that it is not useful service, she would feel angry that the ad made her waste one telephone call.

A foreign ad would be all right, or even better, if it is presented as it was originally created. Translating the copy just to show it as a Nepali ad would be counterproductive.

An example is the recently appearing ad for the Phucchhe Coke from Bottlers Nepal. The message in it "Chiso Bhanekai Coca Cola" is a translation from Hindi "Thanda Matlab Coca Cola". As can be observed very easily, "Thanda Matlab" would have been equally cool also for Nepali consumers. The obsession to translate the message has damaged the original flavour of the message.

However, brandingwise, the coke ad is very cool. Even a kid and an illiterate person can recognize the outline of the bottle as being that of Coke.

Surya Nepal is another producer of excellent pieces of advertisement material. The ad the company produced this month was for the Surya Nepal Masters and Surya Nepal Westen Open Golf Tournaments. The association of the brand Surya with Golf is very appropriate, and the quality of the ad material is very good, commented the panel members.

Finally to the home affairs. The Civil Homes are being advertised with photographs prominently depicting the interior of the houses, while the ads for the competitor brands are showing the exteriors of their respective houses. That may set this ad apart from the rest. But the panel members of this column did not rate this ad a good. First, the headline "Don't get lost when you get home" does not make any sense. Second, the decoration is not complete. It should have some painting or Thangka hanging on the wall. The furnishing is defective. Anyone can see that the plastic cover of the sofa set was  still there when the photograph was taken.

"A total wastage of money", concluded the panel members.