Tough Challenges 

The central bank unveils a new monetary policy amid fears of spiraling inflation

By SANJAYA DHAKAL

The rapid rise in the rate of inflations has become one of the most challenging task before the central bank. At a time when the economic growth rate has remained stagnant, the increase in inflation could further deteriorate the financial health of the country.

So, it was not surprising when the chief of the central bank stated that the number one priority of the new monetary policy was to maintain price stability. Introducing the new monetary policy for the fiscal year 2005/06 on July 22, governor of the Nepal Rastra Bank Bijaya Nath Bhattarai said that maintaining price stability is its major objective.

For the past few years, Nepal did not have to suffer from high rate of inflation even though the economy suffered in many other fronts. The rate of inflations hovered well below 5 percent in the past couple of years. But since last one year, the inflation is sneaking above threatening the financial stability.

The inflation rate based on National Consumer Price Index for the period of first 11 months of the fiscal year 2004/05 stood at 6.2 percent compared to 4.5 percent inflation the previous year. In the current fiscal year 2005/06, the NRB aims to maintain inflation at 5 percent.

The new monetary policy has also left unchanged the Cash Reserve Ratio (CRR) at five percent. Governor Bhattarai, however, said that if the commercial banks decrease the gap between loan interest and deposit interest rates (spread rates), the CRR could be decreased during half-yearly review of the policy.

The central bank has been, of late, applying pressures on the banks to increase the rates of interest on deposits. The central bank is concerned that given the spiraling rate of inflation and decreasing rate of interest on deposits, there is a threat of capital flight. The new policy has increased the bank rates from 5.5 to 6 percent to check this concern.

At present, the average rate of interest on deposits stand at meager 1.75 percent whereas the inflation rate is above 6 percent, which means that depositors are actually losing the value of their deposits. The new policy has also increased the Capital Adequacy Ration (CAR) for banks from 11 to 12 percent.

Apart from measures to contain inflation rate, the new policy has also introduced a number of other measures. It has increased the foreign exchange facility provided to travelers from the maximum of US$ 1000 to US$ 1500. It has also revoked the current system whereupon a traveler could avail of foreign exchange facility by showing his/her passport only once a year. It has also done away with the system of notifying the availing of foreign exchange facility in the passport. The policy has also simplified various provisions to help the importers.

The policy has stated that separate act/rules would be introduced to increase the flow of loan to micro-finance institutions in rural sector. Likewise, a separate act would be introduced to manage the micro-finance institutions and cooperatives.

The policy states that since Nepal needs to open its market for branches of foreign banks from 2010 as per its commitment to WTO, efforts will be pursued to expand and strengthen domestic banks. The policy reiterates the commitment to ensure legal aspects to encourage merger of interested banks and financial institutions.

Bankers and experts have given mixed reaction to the new policy. While some say that the new policy would increase the cost of capital and decrease bank profits, others term it as a realistic policy.

The bankers have welcomed the decision to introduce new laws and rules to facilitate the financial sector. But they are equally cautious about the growing pressure by the central bank to increase the rate of interest for deposits.