Lending rates to be capped within a year; fixed rates planned for productive and export-oriented sectors

KATHMANDU, MAY 27: Nepal Rastra Bank (NRB) is asked to regulate deposit and lending interest rates within a defined range over the next year. The very instruction comes from the Economic Reform Implementation Action Plan prepared by the government. As per the plan, the central bank will ensure that the real interest rate on deposits remains positive and that lending rates stay within either high single digits or low double digits.

"To reduce the interest rate spread between deposits and loans, the central bank must take measures aimed at lowering the operational costs of the banking system, enhancing institutional capacity, and maintaining financial stability. This work is to be completed within one year," the plan mentions. 

For more effective monetary management, the central bank is expected to implement the interest rate corridor efficiently and maintain the interbank rate close to the policy rate. It has also been tasked with gradually narrowing the interest rate corridor band. In addition, the plan directs the NRB to revitalise the bond market and reduce the gap between deposit and lending rates.

At present, the upper limit of the interest rate corridor stands at 6.5 percent and the lower limit at 3 percent. The Ministry of Finance will be responsible for monitoring and facilitating the implementation of the action plan by the central bank. This effort is to continue on an ongoing basis, with the expectation that the gap between the interbank rate and the policy rate will gradually decrease.

The central bank is also required to enhance liquidity management in order to reduce interest rate fluctuations. It must align foreign exchange management and regulatory frameworks with the objectives of monetary policy. Furthermore, the NRB is mandated to maintain foreign exchange reserves sufficient to cover 5 to 7 months of imports of goods and services. Currently, the reserves are adequate to cover imports for 14.2 months.

Over the next year, the central bank will also need to develop the bond market to help stabilize interest rates. It is also expected to promote alternative financing mechanisms to make financial resources more easily accessible at lower interest rates and to implement measures to reduce production and business costs.

Additionally, the NRB is responsible for ensuring that loans directed toward productive and export-oriented sectors are available at fixed interest rates. The action plan includes provisions for offering fixed-rate loans for a set period to these sectors and to first-time homebuyers with stable incomes. The aim is to maintain stable interest rates for a predetermined period.

The plan also outlines the need to adopt measures that lower production and business costs, control black market activities, ensure smooth domestic supply of goods and services, explore alternatives to the existing exchange rate mechanism with the Indian rupee, and keep inflation at a low rate to avoid real exchange rate overvaluation.

To implement the recommendations made by the High-Level Economic Reform Recommendation Commission (2081 BS), chaired by former finance secretary Rameshwor Prasad Khanal, the action plan has provided Nepal Rastra Bank with 23 specific tasks. The 62-page plan includes sector-specific and ministry-wise responsibilities, along with timelines for implementation.

The commission’s recommendations to the NRB span a range of areas, including monetary policy, interest rates, exchange rates, inflation, banking, insurance, the capital market, cooperatives, alternative financing, and the broader investment environment. NRB has been explicitly named as the responsible authority for these actions.

Here are the 23 key directives for Nepal Rastra Bank:

1. Effectively implement the interest rate corridor, maintain interbank rates near the policy rate, gradually narrow the corridor band, and enhance liquidity management to reduce interest rate volatility.

2. Align foreign exchange management and regulatory frameworks with the goals of monetary policy.

3. Maintain foreign exchange reserves sufficient to cover 5 to 7 months of imports of goods and services.

4. Ensure that loans to productive and export-oriented sectors are available at fixed interest rates.

5. Provide fixed-rate loans for a specified period to productive sectors and first-time homebuyers with stable income.

6. Reduce the spread between deposit and lending rates to cut banking system costs, build institutional capacity, and maintain financial stability.

7. Adopt an interest rate policy that keeps the real deposit rate positive and the lending rate within high single digits or low double digits.

8. Develop the bond market to help stabilize interest rate fluctuations in the economy.

9. Conduct research on alternative exchange rate mechanisms to the Indian rupee peg.

10. Keep inflation low to avoid real exchange rate overvaluation and adjust the prevailing exchange rate as needed.

11. Avoid borrowing for recurrent expenditures and issue short-term treasury bills only to manage temporary revenue-expenditure gaps.

12. Raise investment funds for high-return infrastructure projects through the issuance of infrastructure bonds.

13. Allow the Nepal Electricity Authority to issue energy bonds to finance hydropower projects.

14. Enhance the capacity of the Credit Information Center and initiate personal credit scoring with appropriate legal backing.

15. Provide loans at fixed interest rates for 3 to 5 years to productive industries, small and cottage businesses, and exporters.

16. Facilitate margin lending for securities trading through authorized brokers.

17. Establish a committee chaired by the NRB Governor, comprising representatives from relevant agencies, to approve outbound and inbound investment amounts and methods.

18. Work with the Securities Board of Nepal (SEBON) to draft and implement guidelines for issuing Global Depository Receipts (GDRs).

19. Identify over-supplied industries through regular red-flagging and discourage lending to these sectors.

20. Adopt a policy requiring at least 60 percent of total credit to flow into productive sectors, and encourage bank lending in areas such as information technology, renewable energy, and forest-based industries.

21. Set lending rates for productive sector loans at least one percentage point lower than those for consumer loans.

22. Enable farmers to access credit from financial institutions using warehouse receipts issued by authorized operators.

23. Operate the Agricultural Development Bank as a specialised institution dedicated to investment in the agricultural sector.