Cheap credit still a far-fetched dream

Kathmandu, August 5

Industrialist Pashupati Murarka was expecting lending rates to fall following a surge in banks’ deposit collection in the final days of the last fiscal year and introduction of a ‘loose’ monetary policy by the central bank. But he has been disappointed.

“So far, none of the banks that I deal with has reduced interest rates on loans,” said the former president of the Federation of Nepalese Chambers of Commerce and Industry, the largest umbrella body of the private sector, without disclosing names of financial institutions his companies have borrowed money from.

Entrepreneurs like Murarka were expecting lending rates to drop as deposit collection of cash-strapped commercial banks had surged by Rs 113 billion in the final month of fiscal year 2017-18, shows the report of Nepal Bankers’ Association (NBA). This inflow accounted for almost 30 per cent of the total deposit collected by banks in the whole of last fiscal year, which ended on July 16.

Cheap credit ‘unlikely’

The massive hike in deposit was the result of higher public spending, especially capital spending, which, as in the past, had crowded in in the last month of the fiscal year. This helped banks to more than double their stock of loanable funds from around Rs 54.5 billion at the end of Nepali calendar month of Jestha, or 11th month of fiscal year, to around Rs 102.5 billion in Ashad, the final month of the fiscal year, an analysis of NBA’s data shows.

Soon, it was rumoured that credit rates had started falling. But contrary to market expectations, base rate of 12 commercial banks has actually gone up by 0.03 to 0.63 percentage point to up to 12.21 per cent since the second week of May, information gathered from websites of banks shows.

Base rate – the minimum interest at which loans are offered – of only 11 banks has fallen in the range of 0.02 to 0.63 percentage point, while five banks have kept their base rate unchanged since the second week of May.

“Base rate of many banks has not come down as deposit rates are still very high. So there won’t be much change in lending rates in this quarter,” said Rajan Singh Bhandari, CEO of Citizens Bank, one of the financial institutions that has raised the base rate.

The Nepal Bankers’ Association has lately restricted banks from offering more than seven per cent interest on savings deposit and more than 11 per cent interest on fixed deposits. These deposit rates are deemed ‘high’ considering inflation of 4.1 per cent. But while ceilings have been set on deposit rates, there is no limit on lending rates, which stand at as high as 24.6 per cent. Little wonder, the interest spread – the difference between lending and deposit rates – of at least 19 commercial banks has gone up by 0.03 to 1.59 percentage points since mid-April, an analysis conducted by The Himalayan Times shows. This means most of the banks are spending less to purchase deposit and selling relatively cheaper deposit in the form of loans at higher costs to drive up profit.

Rs 1,438 billion investment required

The private sector, which comprises people like Murarka, has always been critical of banks that make credit expensive to maximise profit. This practice, entrepreneurs say, eats into their profit and compels them to slash investments, lowering job creation and ultimately consumer spending.

If this continues, they say, the government may find it difficult to meet eight per cent economic growth target set for the current fiscal year.

The country must invest at least Rs 1,438 billion (current price) in fixed capital assets, excluding land and equipment like private cars, in the current fiscal year to attain eight per cent economic growth target, according to Nepal Rastra Bank (NRB), the central bank. This figure, referred to as gross fixed capital formation (GFCF) in technical terms, is 40 per cent higher than in the last fiscal year and accounts for 41.6 per cent of the gross domestic product.

Of the total GFCF, Rs 432 billion should come from the government and remaining Rs 1,007 billion from the private sector, NRB says.

“The government is likely to meet this investment target as the central government has allocated Rs 314 billion for capital spending in the current fiscal year, while provincial governments have collectively earmarked a capital budget of Rs 121 billion,” said Nara Bahadur Thapa, executive director of NRB’s Research Department.

Higher public capital spending tends to crowd in private investment. But there is a caveat: credit should be affordable and easily accessible to the private sector. This means the country needs to have a good stock of relatively cheaper loanable funds to fuel a wave of new investment.

“The focus of this year’s monetary policy is hence on augmenting loanable funds,” said Thapa.

Erosion in financial self-sufficiency

There is now growing acknowledgement that deposit of domestic households and institutions can no longer bolster the stock of loanable fund as remittance boom has sputtered out and public spending is weak. In other words, the country’s financial self-sufficiency is eroding. The central bank has thus allowed banks and financial institutions to borrow funds equivalent to up to 25 per cent of the core capital from foreign financial institutions, including Indian.

This facility can bring in foreign funds of around Rs 92 billion, which, according to the central bank, must be channelled towards the productive sector. This string has been attached to ensure the foreign currency loans are not used for speculative purpose in real estate and stocks as in Thailand that triggered the Asian Financial Crisis of 1997.

Although a number of commercial banks have expressed interest to use this window to borrow foreign money, they have not been able to do so because of higher insurance cost – which stands at up to seven per cent of the loan amount – to cover the foreign exchange risk.

Foreign banks lend money in US dollar or other convertible currency, which needs to be exchanged into Nepali rupees before banks provide them to borrowers. This money which has been exchanged again needs to be converted to US dollar or other convertible currency when banks have to repay the loan. This is where the risk lies.

Let’s assume exchange rate of each dollar currently stands at Rs 109. This means $1 million will fetch Rs 109 million. Say, after six months when it’s time to repay the debt the value of Nepali rupee has slumped to Rs 114 per dollar. This means the bank will have to fork out Rs 114 million to repay $1 million, generating loss of five million rupees. This risk is inherent in foreign borrowing.

The central bank has now stepped forward and said it will introduce an instrument to hedge this risk.

“What we’ll do is exchange foreign currency borrowed by banks into Nepali rupees and park that foreign fund in a separate reserve. When it’s time to repay the loan we’ll dip into the reserve and offer the same foreign currency to banks at the rate in which it was originally exchanged into Nepali rupees,” Thapa explained the concept behind the hedging facility, which sounds more like a currency swap deal. “We won’t charge anything for providing this service, apart from nominal handling fee,” Thapa said.

Monetary policy not about bookkeeping

The ‘hedging’ facility will be supplemented by the refinancing pool, which, according to the Monetary Policy, will be expanded to Rs 35 billion in current fiscal year. Currently, the pool, which offers loans to good borrowers at concessional rates, contains Rs 20 billion.

Although the pool is yet to be topped up, the central bank has said ‘whether additional money would be added to the pool or not should not be a matter of concern as long as there is assurance of making the funds available’.

“Many believe refinancing pool can be tapped only if there is sufficient fund in it. That is not the case. If there is need we can provide more than Rs 35 billion in refinancing facility without adding money to the pool,” said Thapa, adding, “Monetary policy is not about bookkeeping but about macroeconomic stabilisation. This is why monetary policy should be dynamic and not static.”

Lately, the central bank is also mulling over using the refinancing pool to tame runaway lending rates by using it as a vehicle to transfer government’s surplus funds to the market at times when there is shortage of loanable funds.

“We tried to resort to this measure last fiscal year when credit rates had surged, but could not because many objected to the concept of providing loans without topping up the refinancing pool,” Thapa said. “We’ll try not to let this happen this time to ensure financial sector stability.”