Monetary Policy for 2023/24

Background

1. Monetary policy has been formulated with the major objectives of maintaining price and balance of payments stability as specified in the Nepal Rastra Bank Act, 2002. The policy statement also includes the financial sector, foreign exchange management and payment system-related policies that aim to enhance financial access, maintain financial stability and develop a secure, healthy and sound payment system.

2. The eleven months' data related to the macroeconomic and financial situation of 2022/23 have already been published. The external sector and price situation have improved while the government finance has been under pressure. The growth of credit to the private sector has remained sluggish and the banking system has witnessed a rise in the ratio of their non-performing loan as a result of the slowdown in economic activities.

3. Government of Nepal (GoN) unveiled annual budget for 2023/24 on 29th May 2023. The budget has targeted to achieve 6 percent economic growth and estimated inflation to be within 6.5 percent. The budget has stipulated action plans for economic reforms to achieve these targets. The provincial governments and most of the local bodies have also unveiled their respective budgets for 2023/24. The implementation of the proposed reform programs by the GoN and execution of the capital expenditure as planned in the budget of the GoN and provincial governments is expected to further spur economic activities.

4. International Monetary Fund (IMF) has projected the global economic growth to be weak in 2023 and some improvements in 2024. Despite some improvements in 2023, the Fund has projected the global inflation still to remain high. Though inflation in developed and emerging economies have declined, but its level is still above the target. Therefore, these economies have continued the tighter monetary policy stance.

5. Monetary policy for 2023/24 along with policies related to regulatory, payment system, and foreign exchange management have been formulated considering the international and national economic as well as financial situation and their outlook, policy stances adopted by developed and neighbouring economies, the review of the monetary policy of 2022/23, the objectives and priorities set out in the government budget for 2023/24 and suggestions received from stakeholders, scholars, and the general public.

Review of Monetary Policy for 2022/23 Economic and Monetary Targets

6. The stance of monetary policy for 2022/23 was guided by the objective of keeping inflation below 7 percent. The average inflation up to mid-June 2023 stood at 7.77 percent while the year-on-year (y-o-y) inflation stood at 6.83 percent in mid-June 2023.

7. The foreign exchange reserves available as of eleven months of 2022/23 remained sufficient to cover 9.6 months' imports of goods and services, against the target of maintaining foreign exchange reserves sufficient to cover 7 months' imports of goods and services.

8. The weighted average interbank rate, the operating target of the monetary policy, was set to keep within the corridor of 5.5 percent to 8.5 percent. The annual weighted average interbank rate recorded at 7.13 percent. Monetary Management and Interest Rate

9. A total liquidity of Rs.414.47 billion through the repo auction and Rs.89.70 billion through the outright purchase auction has been injected on transaction basis in 2022/23 under the open market operation whereas a total liquidity of Rs.108.20 billion has been mopped up through reverse repo and deposit collection auction. On transaction basis, a total of Rs.395.97 billion net liquidity has been injected through open market operations in 2022/23. A total of Rs.472.30 billion net liquidity was injected in the previous fiscal year under open market operations.

10. Bank and Financial Institutions (BFIs), on transaction basis, have utilized liquidity facilities worth Rs.2727.11 billion through standing liquidity facility (SLF) and Rs.2286.90 billion through overnight liquidity facility (OLF) in 2022/23. On transaction basis, the BFIs had utilized Rs.9170.10 billion through the SLF in the previous fiscal year.

11. Liquidity of Rs.712.50 billion has been injected in 2022/23 through the net purchase of the US Dollar in the foreign exchange market. A total of Rs.355.56 billion liquidity was injected through the net purchase in the previous fiscal year. The improvements in the remittance inflows and a fall in imports have resulted in a higher volume of the net purchase of the US Dollar.

12. Short-term interest rates have decreased in recent months following the improvements in the external sector. The weighted average interbank rates among commercial banks have continuously declined to 2.98 percent as in mid-July 2023. The interbank rate was 6.99 percent in mid-July 2022 that reached a peak of 8.5 percent in mid-October 2022. Similarly, the 91 day's weighted average treasury bill rate declined to 6.14 percent in mid-July 2023. The treasury bill rate remained 10.66 percent in mid-July 2022 after reaching the peak of 10.89 percent in mid-January 2023.

13. Long-term interest rates have also started to decline in line with short-term interest rates. The base rate of commercial banks which increased to 10.91 percent in mid-January 2023 has fallen to 10.18 percent in mid-June 2023. Similarly, the weighted average deposit rate that increased to 8.51 percent in mid-January 2023 has declined to 7.99 percent in mid-June 2023. The weighted average lending rate of commercial banks that reached as high as 13.03 percent in mid-February 2023 gradually declined to 12.53 percent in mid-June 2023.

Sectoral Credit, Deprived Sector and Concessional Loan

14. Out of the total lending of commercial banks, 13.1 percent (Rs.552.99 billion) lending has been in the agriculture sector, 6.8 percent (Rs.286.77 billion) in the energy sector and 9.9 percent (Rs.418.36 billion) in the micro, cottage, small and medium enterprises sector in mid-June 2023. Likewise, development banks have extended 24.9 percent (Rs.113.18 billion) and finance companies extended 22.3 percent (Rs.19.65 billion loans) of their total outstanding loan in the agriculture, micro, cottage, and small enterprises/businesses, energy, and tourism sectors in mid-June 2023.

15. The deprived sector lending stood at 6.1 percent (Rs.260.84 billion) on average in the total outstanding loan of the commercial banks as of mid-June 2023. Similarly, development banks and finance companies have extended 9.1 percent (Rs.42.32 billion) and 6.1 percent (Rs.5.65 billion) of their outstanding loan respectively.

16. The concessional loan under the interest subsidy program of the GoN has provided to 147 thousand 510 borrowers with an outstanding amount ofRs.203.10 billion in mid-June 2023. The outstanding refinance facility provided by the NRB in the productive sectors including agriculture, micro enterprises, export and the Covid-19 hard-hit sectors remained Rs.1.96 billion in mid-June 2023.

Implementation Status of Major Regulatory Provisions of Monetary Policy for 2022/23

17. For strengthening monetary management and thereby improve liquidity management, a provision of providing overnight liquidity facility (OLF) to BFIs has been started since 16th December 2022. Similarly, a rule to conduct open market operations (OMO) has been introduced so that OMO interventions will take place if the weighted average interbank rate deviates by the specified percentage point away from the policy rate.

18. The existing monetary policy framework has been timely improved to make effective liquidity management and thereby limit the volatility in interest rates, reduce financial intermediation costs, and strengthen the monetary policy transmission. Since 2022/23, a monetary policy rule has been introduced in which the annual inflation target and the import capacity of the foreign exchange reserves are taken as a basis for setting the policy rate. According to this rule, the policy rate will be revised upward when there is pressure on inflation and import capacity of foreign exchange reserves, and will be revised downward when there is no pressure. With this rule, the process of setting the monetary policy stance has now been both data and theory driven. This policy rule is believed to make the setting of monetary policy stance more transparent and make the policy more effective to maintain macroeconomic stability.

19. As per the provisions in the monetary policy for 2022/23, a procedure for the lender of the last resort facility has been issued. The procedure has made clear provisions regarding the qualification of the related institutions, instruments, and procedures to follow while using the lender of the last resort facility from the NRB in case BFIs, though solvent in medium to long term, but are unable to manage immediate short-term liquidity requirement.

20. The existing provision of determining interest rates on lending has been revised in 2022/23, so that lending rates can be set on a monthly basis as per the cost of funds. It is expected to enhance the effectiveness of the monetary policy transmission mechanism through bringing timely adjustment in the demand for and supply of loanable funds.

21. A provision that commercial banks need to maintain average interest rate spread of 4 percent has come into effect from mid-July 2023. Likewise, the spread requirement for development banks and finance companies to keep at or below 4.6 percent has also come into effect.

22. A provision of allowing to add a maximum of 2 percentage points premium to the base rate while determining the lending rate has come into implementation for loans up to Rs.20 million provided to food production, animal husbandry, fishery, export, as well as manufacturing industry, handicraft, and skill-based businesses and enterprises with 100 percent local raw materials. Likewise, an arrangement of adding a maximum of 2 percentage points premium to the base rate has come into effect while providing credit to the private sector for establishing information technology park and industrial park.

23. The microfinance program has been helpful in developing skills and entrepreneurship of the deprived people as well as promoting the microenterprises in addition to providing financial services. Access to financial services of the deprived people has been enhanced further by the extension of the micro-savings and credit products. This has not only provided the opportunity to choose financial products but also minimized the risk for the deprived people being exploited by informal finances. In order to make the deprived sector lending further concessional, a provision of adding a maximum of 2 percentage point premium to the base rate while providing wholesale lending to the microfinance institutions has been brought into implementation.

24. The Foreign Investment and Foreign Loan Management Bylaw 2021 has been amended to further facilitate the receipt of foreign currency from foreign investment, repatriation of foreign investment as well as earnings made from that investment, approval and receipt of foreign loans and providing foreign exchange facilities for the repayment of principal and interest of such loans, among others.

25. By issuing Nepal Rastra Bank Remittance Regulations, 2023, the issuance of licenses for carrying out remittance transactions, regulation of remittance transactions, and merger or acquisition of licensed remittance companies have been further systematized.

26. A provision has come into operation that BFIs and remittance companies can bring remittances to the home country through cards issued in collaboration with licensed payment system operators.

27. A provision has come into place that a natural person or any firm, company, or institution established in Nepal and exporting services to any foreign firm, company, institution, or natural person could receive the convertible foreign currency through the banking channel.

28. The details of the implementation status of the policy provisions of the Monetary Policy for 2022/23 are provided in Annex 2.

Macroeconomic Situation and Outlook

Global Economic Situation and Outlook

29. The global economic growth rate has remained subdued due to a rise in interest rates which was raised in response to the higher inflation caused by the Russia-Ukraine war, rise in the price of petroleum products and global supply disruption. International Monetary Fund (IMF) has projected a lower economic growth rate for the world, advanced, and emerging economies in 2023 and a moderate improvement in 2024.

30. According to the IMF’s projection of April 2023, the world economy which expanded 3.4 percent in 2022 is estimated to grow 2.8 percent and 3 percent in 2023 and 2024 respectively. Advanced economies that expanded 2.7 percent in 2022 is estimated to grow 1.3 percent in 2023 and 1.4 percent in 2024 as per the IMF projection. Emerging and developing economies which grew 4 percent in 2022 is projected to expand 3.9 percent and 4.2 percent in 2023 and 2024 respectively.

31. The neighbouring economies, India and China, are estimated to grow 5.9 percent and 5.2 percent respectively in 2023, compared to a growth of 6.8 percent and 3 percent respectively in 2022. The Fund projects economic growth of 6.3 percent for India and 4.5 percent for China in 2024.

32. The elevated inflationary situation faced by the global economy has been gradually easing. However, the inflationary risk is continued on account of uncertainties in energy prices, the ongoing Russia-Ukraine war and the likelihood of adopting easy policy to overcome the economic recession. As per the projection of the IMF, global inflation, which remained at 8.7 percent in 2022, is estimated to decrease to 7 percent in 2023 and further to 4.9 percent in 2024. Inflation of the developed and developing economies is projected to be 4.7 percent and 8.6 percent respectively in 2023 and to decline to 2.6 percent and 6.5 percent respectively in 2024, compared to 7.3 percent for developed and 9.8 percent for developing economies in 2022.

33. Most of the central banks around the world have been continuing their tighter monetary policy stance since the beginning of 2022. The Federal Reserve Bank of America has held off the rate hike in the last 14th June 2023 meeting, while the rate was being continuously increased from 0-0.25 percent in March 2022 to 5-5.25 percent on 3rd May 2023. Emerging economies have also continued their tighter monetary policy stance to anchor the higher inflationary expectation as well as evade the effects of tighter monetary policy of advanced economies in their financial markets.

34. The Reserve Bank of India, by continuously increasing the policy rates, has set the repo rate at 6.5 percent and the standing liquidity facility rate at 6.75 percent in February 2023. RBI has, however, kept rates unchanged in the review of monetary policy in June 2023. The Central Bank of Bangladesh has increased the policy rates thereby setting repo rate at 6.5 percent, standing liquidity facility rate at 8.5 percent and the standing deposit facility rate at 4.5 percent.

35. The rise in the price of petroleum products, foods and metallic commodities induced by the Russia-Ukraine war has currently remained stable or even showed a declining trend. As a result, inflation is in a decreasing trend in most of the world economies. However, most economies seem to continue their tighter monetary policy stance in 2023 given the current inflation being above their targeted level and the ongoing geopolitical tensions that pose risks to fuel and the overall price situation.

Domestic Economic Situation and Outlook Real Sector

36. National Statistics Office (NSO) has estimated economic growth of 2.16 percent at the basic price and 1.86 percent at the producer's price for 2022/23. Internal liquidity absorption due to the higher balance of payments (BoP) deficit in the previous year and capital expenditure being less than the budget allocation contributed to lower domestic demand which severely affected the construction, mining and quarrying, manufacturing and wholesale and retail trade sectors. These sectors are estimated to register a negative growth in 2022/23.

37. The budget for 2023/24 has targeted economic growth of 6 percent. The GoN has allocated Rs.302.07 billion for capital expenditure and the budget has also outlined broader action plans for economic reforms. Similarly, provincial governments have allocated Rs.159.49 billion for capital expenditure. Execution of the proposed action plans for the economic reforms and execution of capital budget as planned is expected to further stimulate the private sector investment thereby helping to achieve the targeted economic growth.

38. According to the Ministry of Agriculture and Livestock, about 53 percent of paddy plantation has been completed as of 14 July 2023. About 65 percent of paddy plantation was completed by July 14 last year. The paddy plantation progress is less than last year due to the delay in the monsoon and lumpy skin disease. Thousands of livestock’s have died due to the lumpy skin disease. However, due to the active monsoon, easy availability of the chemical fertilizer and timely fixation of the minimum support price of paddy by the government that has removed the price uncertainty, the agricultural sector is expected to register a satisfactory growth in 2023/24.

39. About 900 MW of electricity is expected to add to the national grid system in 2023/24. With the permission received to sell an additional 300MW electricity to the Indian market on June 26, 2023, Nepal is now able to sell a total of 952 megawatts of electricity in the Indian market. The increased export of electricity will help to reduce the trade deficit with India and to improve the external sector, thereby supporting the domestic economy to gain further momentum.

40. The tourist arrival improved since the beginning of 2022/23. Following the reduced impact of COVID-19, international travel standards have been eased and the business environment is becoming convenient. The GoN has announced the 2023-2033 to be a Visit Nepal decade. The tourism-related infrastructures like hotels, and airports have been expanded. As a result, a continuous growth in the number of foreign tourist arrival and the further expansion of the tourism sector in the coming years is expected.

41. The construction and its interlinked sectors have contracted in 2022/23. To help the construction sector gaining momentum which has a strong backward forward linkage to wholesale and retail trade, mining and quarrying, manufacturing, among others, it is necessary to make arrangement for timely capital spending on the development activities like infrastructures. This will further increase the private demand in other sectors and support achieving the targeted economic growth.

42. The declining trend of the interest rate following the external sector improvements will support to increase private demand, and thereby expand economic activities further. Remittance inflow is expected to remain satisfactory due to the higher number of Nepali people who have gone for foreign employment abroad. However, the emigration of Nepali youths for employment and study abroad has contributed to some extent to lower domestic demand.

Inflation

43. The annual average consumer price inflation is expected to remain slightly above the targeted level. The average consumer price inflation for eleven months of 2022/23 is 7.77 percent, while such inflation was 6.18 percent in the same period of 2021/22. However, the y-o-y consumer price inflation registered 6.83 percent in mid-June 2023, being slightly below the average annual expected inflation. The increase in the prices of cereals, dairy products, spices, household consumables, imported goods, and fuel along with the depreciation of Nepalese Rupees against the US Dollar has generated pressure on inflation. However, the inflationary pressure seems to gradually ease in response to subdued domestic demand and the declining trend of wholesale price in India.

44. Nepal’s consumer price inflation is primarily determined by domestic production and demand, the price of imported goods, the exchange rate of Nepalese Rupees and the margin to be marked up by wholesalers and retailers. Expanding domestic production, setting the policy stance to balance the demand and supply, and strengthening market regulation for checking artificial price hikes are necessary to contain inflation within the targeted level.

45. In the inflation expectation survey conducted in mid-July 2023, public expectation for inflation has remained stable for both next three months and one-year ahead period.

46. Inflationary pressure at the international level has been easing. However, uncertainty of crude oil price and the ongoing Russia-Ukraine war still pose risks to price. Considering the existing tighter monetary policy stance at the global level, declining inflationary trend, well-anchored public's inflationary expectation, and the base price effect, inflation is expected to remain within 6.5 percent in 2023/24.

External Sector

47. Foreign trade has declined in 2022/23. During eleven months of the review year, the total merchandise exports decreased 22.7 percent amounting Rs.143.59 billion whereas merchandise imports decreased 16 percent amounting Rs.1480.98 billion. As a result, the trade deficit has improved 15.2 percent to Rs.1337.39 billion in comparison to the previous year. Given the size of the budget, the current trend of remittance inflows and the decreasing trend in the interest rates, imports of goods and services is projected to grow by about 16 percent in 2023/24.

48. The BoP situation has improved in 2022/23. In the eleven months of 2022/23, the BoP is in surplus of Rs.228.98 billion. However, the current account is in deficit by Rs.69.40 billion. In the same period of the previous year, the BoP was in deficit of Rs.269.81 billion and the current account was in deficit of Rs.592.14 billion.

49. Remittance inflows remained satisfactory in 2022/23 mainly due to elevated level of Nepali youths going abroad for foreign employment in new destinations and countries having higher income as well as because of the incentives provided for inward remittance inflows. In the eleven months of 2022/23, remittance inflows increased 22.7 percent in Nepali Rupees and 13.0 percent in the US Dollar terms. Even if the number of Nepalese going abroad for foreign employment is significant in post COVID-19 period, however, the growth rate of remittance inflows in 2023/24 is expected to remain moderate given the higher base of remittance inflows in 2022/23.

50. Travel income increased 94.3 percent in 2022/23. Such income is estimated to be at satisfactory level in 2023/24 also.

51. The foreign exchange reserve is in a comfortable position. Gross foreign exchange reserve increased 21.8 percent to Rs.1480.87 billion in mid-June 2023 in comparison to mid-July 2022. In the US Dollar terms, the gross foreign exchange reserves increased 18.5 percent to Rs.11.30 billion. There is a risk of downward pressure in foreign exchange reserves if growth of remittance remains moderate but import grows significantly. Therefore, priorities should be given to export and tourism promotion, foreign investment and remittance inflows through formal channels for sustainable improvements in the external sector.

52. Considering the private sector credit growth, size of the budget and foreign assistance, direction of foreign trade and the trend of remittances inflows, current account deficit seems to widen. However, the BoP is estimated to remain moderately surplus in 2023/24. Government Finance

53. According to the data of GoN, Ministry of Finance, Financial Comptroller General Office, the total expenditure of the Nepal government increased 10.3 percent and total revenue mobilization decreased 10.4 percent in 2022/23 compared to 2021/22. Out of the total budget outlay recorded in 2022/23, the share of the recurrent and capital expenditure were 70.35 percent and 16.34 percent respectively. Of the total budget allocation, 85 percent of the recurrent expenditure and 61.4 percent of the capital expenditure were realized respectively.

54. The total revenue mobilization of the Nepal government was Rs.957.15 billion and the total expenditure realised was Rs.1429.56 billion in 2022/23. These statistics show a revenue deficit of Rs.472.41 billion. Such a revenue deficit was Rs.228.29 billion in the previous fiscal year.

55. On the backdrop of the limited internal resources due mainly to low domestic saving and not to crowd out private investment, the GoN has prioritized the mobilization of external resources in the budget of 2023/24 to fill up the rising revenue deficit. The recent improvements witnessed in the external sector as well as in interest rates could be sustained if resource gap is managed through foreign investment, foreign debt, and foreign assistance.

Monetary and Financial Sector

56. The broad money supply increased 10.9 percent in mid-June 2023 on y-o-y basis. During the period, the total deposit mobilised by the BFIs increased 12.2 percent and credit to the private sector increased 3 percent. The growth projection for the broad money supply was 12 percent while for the credit to the private sector was 12.6 percent for 2022/23. The demand for credit remained subdued due to the lack of timely and planned turnout of the government's capital expenditure, sluggish economic growth and rise in interest rate in response to tighter liquidity condition. As a consequent, the credit expansion remained low in 2022/23.

57. The BFIs have mobilised a total deposit of Rs.88 billion from the remittance receipt in the accounts opened by Nepali people working abroad. Out of this total amount, 86.4 percent is held in fixed deposits.

58. The outstanding credit to the private sector from BFIs is estimated to reach Rs.4877 billion in mid-July 2023 or equal to 90.7 percent of the GDP. The average credit-to-deposit ratio stands at 81.62 percent in mid-July 2023.

59. The current trend of remittance inflows, improvements in the liquidity position, declining trend of interest rates, proposed reform plans in the budget and the turnout of the capital expenditure of the federal and provincial governments as planned in the budget are expected to make economic activities buoyant and raise the private sector demand for credit. Considering the potential demand for credit and additional credit capacity of banks and financial institutions, the credit to the private sector is projected to increase by up to Rs.562 billion in 2023/24.

Monetary Policy Framework for 2023/24

Situation of Monetary Policy Stance

60. Pressure on the external sector has subsided as a result of policy actions. The BoP has been remaining surplus since mid-October 2022. The liquidity situation in the banking sector has been easing along with the improvements in the external sector. As a result, the short-term interest rates have decreased and the long-term interest rates are in a declining trend. Thus, given the improvements witnessed in external sector and liquidity situation, economic activities are expected to expand. In the context of current account deficit and higher import-to-GDP ratio, a strategy of managing the domestic demand that spurs economic activities as well as preserves the achievements made so far in the external sector has been adopted.

61. Even if remittance inflow has increased the money supply, it has not been contributing to value addition domestically, resulting in a wider gap between the domestic production capacity and the demand. As a result, the current account of the external sector is in deficit for the last few years. As Nepal is following the fixed exchange rate regime, the persistence current account deficit not only poses vulnerabilities to the external sector but also to the domestic economic stability. Therefore, the monetary policy has been oriented to focus on maintaining the overall macroeconomic stability by managing the aggregate demand in a way that strikes proper balance between domestic demand and supply.

62. Nepal's potential output growth seems to be around 4.5 percent. An NRB study shows that inflation higher than 6.5 percent may negatively affect economic growth in Nepal. Therefore, for supporting to achieve high and sustainable economic growth along with maintaining the price and external sector stability, monetary policy accords a priority to mobilize resources in sectors where prospectus of building capital is high and expand the production possibility frontier of the economy.

63. Consumer price inflation in Nepal is still higher than India. In the context of the fixed exchange rate regime with Indian currency and about two third of the total imports come from India, Nepal's consumer price inflation is generally influenced by Indian inflation. However, the role of foreign currency reserves is equally important in controlling inflation for the country like Nepal with weak export capacity and import-dependent production and consumption structure. If the excessive expansion in the aggregate demand deteriorates the import capacity of the available foreign currency reserves, it also affects the domestic supply chain and the business environment, leading to a higher inflation domestically despite of lower inflation in neighbouring countries and around the world. Therefore, the monetary policy has cautiously been formulated without putting undue pressure on the foreign exchange reserve and the exchange rate peg from excessive rise in domestic demand.

64. The monetary policy of 2022/23 has started the provision of not setting the policy rate below the annual expected inflation. There is also a practice of taking the natural rate of interest as a reference, to keep the policy rate at a desired level. While the natural rate of interest rate cannot be measured directly, the average long-run inflation can be considered as a good estimator among the available statistical and econometric methods. Nepal's average inflation for the last 25 years is 6.7 percent. On this basis, Nepal's natural rate of interest can be assumed to be around 6.5 percent. In case the policy rate is below the natural rate of interest, there could be undue pressure on the external sector, and domestic economic activities could be suppressed in case policy rate is above the natural rate. Therefore, while determining the policy rate, the natural rate of interest is taken as a reference rate, in addition to inflation and external sector outlook.

65. Gross domestic saving has remained below 10 percent of GDP for a very long period in Nepal. The lower domestic saving but higher investment demand has been increasing the resource gap. International competitiveness has not increased due to the lower productivity of public and private sector investment while the investment multiplier and the domestic saving rate is also at very low level. For increasing the saving rate, the rate of capital formation needs to be increased by mobilising the public and private investment towards the sectors with a higher return. In this context, a strategy of maintaining a positive real interest rate on deposits to promote saving has been followed while setting the policy rate.

66. Private sector credit to GDP ratio is very high in Nepal compared to the South Asian region. Nepalese private sector seems to be in an over-indebted situation when the total lending from BFIs, cooperatives, insurance companies, Citizen Investment Trust and Employee Provident Fund is considered together. The non-performing loan has started to increase due to the private sector's overindebtedness, the poor relationship between the credit and real sector, and some non-professional activities targeted against the financial sector in recent days. In this background, the utmost priority has been given to maintaining financial stability.

67. The banking sector's average credit growth has registered 19.4 percent in the last 20 years. Along with the rise of the private sector credit to GDP ratio, the number of larger size loans has also grown. However, the growth of the real sector is less than expected compared to the credit flow to this sector. When the financial sector expands but not the real sector, it not only affects the financial stability through poor financial asset quality but also deteriorates the real sector and government finance in the long run. Therefore, the emphasis has been given to enhancing the productive usage of the credit than its growth, priority to small and medium productive sector loans, and reducing the overconcentration of the credit.

68. The market supply chain disrupted by the COVID-19 pandemic and the Russia-Ukraine war is yet to come in normal order. The higher inflationary pressure in both developed and developing countries built mainly through the elevated petroleum and food prices has been improving slowly but the overall inflation level is still much higher than their targeted level. As a consequence, the majority of the central banks have been continuing the tight monetary policy stance. As a result, pressure in the financial sector of both emerging and developing economies still continues. The policy stance around the world has also been considered while formulating this monetary policy.

Monetary Policy Stance

69. The stance of monetary policy has been kept cautiously accommodative to make the economy buoyant by maintaining price and external sector stability.

70. The priority of the monetary policy is to enhance the domestic production capacity by channelling financial resources to the productive sector.

71. Regulatory policies have been formulated for supporting the monetary policy to maintain financial stability by enhancing the effectiveness of the monitoring, regulation and supervision of large-scale credit, reducing the over-concentration of the credit, prioritising small and medium-productive sector credit and enhancing the quality as well as accessibility to the credit.

Monetary Policy Framework and Targets

72. The exchange rate peg of the Nepalese Rupee vis-a-vis the Indian Rupee as a nominal anchor of the monetary policy has been kept unchanged.

73. The weighted average interbank rate among the BFIs has been continued as an operating target of the monetary policy.

74. The policy rate will be determined based on the import capacity of the foreign exchange reserves and the annual expected inflation.

75. Based on the status of the operating target, the interbank rate will be kept within the interest rate corridor by proactively conducting open market operations.

76. The goal of the monetary policy is to keep the foreign exchange reserves at a level that is sufficient to cover at least 7 months' imports of goods and services.

77. To contain the inflation within 6.5 percent, monetary management will be carried out so that monetary expansion will not put pressure on the price level.

78. Priority is given to channelize financial resources towards the productive sector and thereby support achieving the economic growth of 6 percent targeted by the GoN in the budget for 2023/24. The growth rate of the broad money supply and the credit to the private sector from the BFIs is projected to be 12.5 percent and 11.5 percent respectively in 2023/24. Monetary Measures

79. Considering the domestic and external economic outlook, the policy rate has been reduced by 50 basis points to 6.5 percent. Keeping the bank rate unchanged at 7.5 percent, the deposit collection rate has been reduced to 4.5 percent from 5.5 percent.

80. Secondary open market operations and deposit collection auction will be opened if the weighted average interbank rate, taken as an operating target, becomes higher than the bank rate and lower than the deposit collection rate.

81. The provision of providing a standing liquidity facility (SLF) at the bank rate and an overnight liquidity facility (OLF) at the policy rate has been kept unchanged.

82. A provision will be made to provide the standing deposit facility (SDF) at the lower bound of the interest rate corridor in order to make IRC more effective.

83. Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR) have been kept unchanged.

Financial Sector and Foreign Exchange Policies for 2023/24

84. The size of the financial sector and financial outreach have been remarkably improved as a result of the reforms being continuously implemented by the NRB for the development and expansion of the financial sector. Adoption of the international best practices and their effective implementation have been a priority for the stability of the financial sector. BFIs have been consolidated through raising their capital base as well as mergers and acquisitions. As a result, the capital fund mobilized by the BFIs has reached about 13 percent of the GDP, while the mobilization of financial resources has reached about Rs.5700 billion in mid-July 2023.

85. Working capital guideline is now in implementation in order to enhance the utilization of financial resources with the objective of promoting financial stability. A separate large exposure framework is being prepared to supervise big borrowers effectively. Likewise, a revision of single obligor limit underscores a top priority to reduce credit concentration and promote small and medium productive enterprises. Similarly, reform initiatives like assessing the quality of assets in the banking sector, reducing credit risk, developing and using the supervisory information systems to enhance supervisory capacity, preparing and implementing the macro stress testing framework to assess the pressure that financial sector may face due to the macroeconomic fluctuations, timely reviewing and amending the laws related to the financial sector, among others, have been continued. It is expected that afore-mentioned reforms will promote financial stability and help achieve sustainable economic growth.

86. The current account of the external sector has been made fully convertible to enhance market access and integrate Nepal's market with the international market, while the capital account has also been gradually opened up on a need basis. Foreign exchange policy has been formulated and implemented to harmonise it with monetary and financial sector policies to enhance the productive use of foreign exchange reserves.

87. Physical infrastructure, legal and regulatory measures related to payments and settlements have been developed to make electronic payments simple, safe and effective. In addition, the usage of modern equipment and technology has been emphasized to promote electronic payments by integrating with international gateways. There has been a significant expansion in the payments and settlement of electronic transactions due to these initiatives.

88. In line with the monetary policy stance for 2023/24, the following legal, regulatory and foreign exchange management as well as payment systemrelated policies have been formulated. Regulation and Supervision

89. Necessary amendment process to the existing Banking Offence Act 2007 will be moved forward including the provisions for controlling the nonprofessional and violent activities affecting the financial sector stability. 90. The directives related to anti-money laundering will be issued based on the suggestions received from the mutual evaluation, among others. Similarly, the necessary amendments to the related laws and formulation of a national strategy will be facilitated.

91. The limit of the first residential home loan will be increased from Rs.15 million to Rs.20 million. 92. The current provision of providing at least one percentage point additional interest rate by BFIs for remittance account opened by Nepali people working abroad has been continued.

93. The Working Capital Guideline will be reviewed on the basis of the suggestions received from the BFIs.

94. Stressed Loan Resolution Framework will be issued by incorporating the measures and procedures to be followed for the loan rescheduling, rehabilitation and other management of the borrowers who are in problem due to the natural disaster or other special circumstances.

95. Asset Quality Review of commercial banks will be conducted and the guideline for Internal Credit Risk Grading of the BFIs will be formulated and implemented.

96. National level development banks will be required to fully comply the Capital Adequacy Framework, 2015.

97. Necessary policy will be formulated to implement the Expected Credit Loss (ECL) Model as per the National Financial Reporting Standards (NFRS).

98. Provisions of lending requirement to the specified sectors will be reviewed by analysing the current situation of the credit flow.

99. As per the budget statement of GoN for 2023/24, the provision of compulsory requirement of Permanent Account Number (PAN) for the borrowers who utilize the credit above certain limit from the BFIs will be reviewed.

100. Existing investment-related provisions will be reviewed to facilitate the investment of the BFIs to Private Equity Fund/Venture Capital Fund approved by the Securities Board of Nepal.

101. Necessary coordination will be made with other related agencies to develop a credit scoring measurement system.

102. As per the the budget statement of the GoN for 2023/24, NRB will facilitate to establish a separate specialised regulatory agency to effectively regulate and supervise saving and credit cooperatives.

103. To facilitate the exchange of information of customers among the BFIs and other payment-related entities, necessary coordination will be made to develop and implement a centralized Know Your Customer (KYC) system by integrating with the National ID being issued by the GoN.

104. Financial Corporation Survey will be prepared and published to measure the financial depth by incorporating the balance sheets of microfinance financial institutions, insurance companies, Citizen Investment Trust, Employees Provident Fund and other non-bank financial institutions in addition to the BFIs.

105. Considering the necessity of capable human resources and their performance for the stability of the banking system, a study related to human resource development and management in the banking sector will be conducted. A provision will be made in which individuals should pass the entrance exam to enter the banking service and personnel who have completed certification courses from institutions like National Banking Institute will get priority for further career development.

106. The existing risk weight of margin nature loans, real estate loans and hire purchase loans will be reviewed.

Microfinance

107. Recommendations of the study report prepared by the committee formed to study the problems and suggestions related to microfinance financial institutions will be gradually implemented.

108. Merger and acquisition of microfinance financial institutions will be promoted by availing the existing facilities for institutions who commence joint operation by mid-July 2024.

Payment System

109. Further actions will be taken on the basis of the study done on the issuance of Central Bank Digital Currency.

110. Collection of government revenue by using electronic payment instruments in the major public service delivery offices will be facilitated.

111. The provision of receiving foreign currency through electronic means from the export of information technology and other services will be made more effective.

112. The transactions of the institutions involved in electronic payment will be settled through the system of the NRB by synchronising in line with the Principles for Financial Market Infrastructure (PFMI).

Foreign Exchange Management

113. As mentioned in the budget statement of the GoN for FY 2023/24, necessary amendments will be made to 'Nepal Rastra Bank Foreign Investment and Foreign Debt Management Bylaw' to simplify and facilitate the processes related to foreign investment.

114. A provision will be made to provide the foreign currency exchange facility through commercial banks up to a certain percentage of their foreign currency earning made by the service exporting industry/businesses like information technology based on the specified documents. Such a foreign exchange facility will avail to establish contact offices in third countries, to make payments to foreign entities/ transfer the funds to their bank accounts located abroad, and to purchase software or programs and install the equipment.

115. The existing provisions related to the imports through the draft/TT and DAP/ DAA will be reviewed as necessary.

116. Necessary arrangements will be made to include the items identified by the Nepal Integrated Trade Strategy in the existing lists of items eligible for backto-back letter of credit facility.

117. The existing provision of providing up to US Dollar 1,500 foreign exchange twice a year as a passport facility to Nepalese travelling abroad other than India will be revised to the US Dollar 2,500.

118. Necessary arrangements will be made to allow the air service providers to pay the various service

fees abroad up to one hundred thousand US Dollars or other equivalent convertible foreign currency directly through licensed "A" class commercial banks, on the approval/recommendation of the regulatory body and presenting the other prescribed documents.

119. Since the spread and impact of Covid-19 has diminished, the existing provision of allowing foreign currency denominated loans to be paid in Nepali rupees will be removed.

120. To manage the inherent foreign exchange risks of the external loan taken by the BFIs with the approval of this bank, arrangements will be made to introduce swap and other instruments based on the study done so far.

Finally,

121. The implementation of this policy is expected to promote macroeconomic stability, enhance the productive use of financial resources, expand financial access and help achieve the goal of high and sustainable economic growth.

122. Necessary revisions will be made in policies related to the monetary, financial sector, payment system and foreign exchange management by doing quarterly reviews of the economic and financial situation. 123. We would like to express our gratitude to all stakeholders including the agencies of the GoN, organizations related to various businesses and industries, BFIs, scholars, media and others for their support during the formulation of monetary policy for 2023/24. The Bank expects continuous cooperation from all stakeholders for the implementation of the provisions and programs envisioned in this monetary policy.

Source: Nepal Rastra Bank