Is the banking crisis (in Nepal) real?

Is the banking crisis real?
Myrepublica, 27-Dec-09
DR RAGHAB D PANT

With the publication of Current Macroeconomic Situation by the Nepal Rastra Bank recently, based on data of the first three months of the current fiscal year, there have been discussions among the public and in the media arguing that the economy has been hit by three problems at the same speed. They are: (i) the problem in the banking sector due to concentration of its loan – 60.9 percent (or Rs 263 billion, which is equivalent to 30 percent of gross domestic product) of the outstanding loan to be precise – with the security of land and buildings; (ii) decline in the growth of inflow of remittances; and (iii) deficit in the balance of payments totaling Rs 19 billion in the first three months of the current fiscal year. In the first three months of the last fiscal year, the country had experienced a surplus of 8 billion in its balance of payments.

The first problem, however, is not new: It was there and published for public information in the monthly report of the Nepal Rastra Bank. In August, 2009, for example, the total loan with the security of land and buildings was also precisely 60.9 percent of the total and almost the same in September, 2008 (Nepal Rastra Bank, Current Macroeconomic Situation, Monthly Reports, various issues). So, it was a normal affair—though the way we Nepalis used to run the banking system, it was sure to hit the tsunami soon.

Suddenly, in a few newspapers on Dec 17, there was news that the economy is in the midst of serious problems supported by the statement of the Secretary of Finance. According to the Finance Secretary, the decline in the growth rate of remittances and increase in the trade deficit due to rise in import and decline in export were the main reasons of the problem and “ if we did not attempt to reduce import soon, the exchange rate of Nepali currency vis-à-vis Indian currency need to be depreciated.” (Nagarik, Dec 17).

I am perhaps naive, but how can we reduce import when the growth in real income – popularly known as gross domestic product (GDP) at constant prices – is substantially lower than the growth in nominal income? This means that trade deficit will continue to grow as long as there is high receipts from remittances and slow growth in GDP.

In Nepal, the receipts from remittances have been the single most important factor determining the level and direction of economic activities of the country, both at the micro and macro levels. A marginal instability in this source will disturb the foundation of the economy and is expected to be more dangerous than the current political problem.

The foreign exchange reserve of the banking system has been increasing due to rising receipts from remittances and this source has helped the individual family to increase its consumption in excess of the rise in income from domestic source. The import, however, has to go up to meet the increase in national consumption at a rate higher than the growth in real income. This has led to the deterioration in the foreign trade balance of the country but, at the same time, it has been instrumental for the increase in government revenue due to rising receipts from import duties.

As far as the exchange rate is concerned, it is also an old problem. We have been writing since the past several years about the need to depreciate the exchange rate of Nepali currency vis-à-vis Indian currency due to several reasons, including (i) rising deficit in merchandise trade account and , presumably, (ii) capital flight due partly to political disturbances and due partly to difference in the productivity of capital between the two countries (For details, see Exchange Rate Management: The Emerging Problem and the Options, The Himalayan Times, June 2, 2008).

Against this background, I don’t see any new problem emerging; it is the continuation of the same old problem except that the government is not yet ready to change the exchange rate of the Nepali currency. On the contrary, they are trying to find a way to impose some restrictions on the import of goods and services from India to maintain current exchange rate. In fact, the central bank, according to newspaper reports, has already issued several directives to the commercial banks to impose restrictions on financial transaction with India. (The Kathmandu Post, Dec 18) Otherwise, it is not a new problem and the Ministry of Finance is well aware of the situation of the banking system as it has representation in the Board of Directors of the Nepal Rastra Bank too. So the main question is: What were the members of Board of Directors of the Nepal Rastra Bank doing when the country was certain to hit the iceberg?

The problem does not look so serious in the short run but overtime it may get worse. The foreign exchange reserve of the monetary authorities, for example, was sufficient for more than 10 months of import in October, 2008, but declined to reach 8.5 months of import in October, 2009, due partly to the continuous increase in import and due partly to the decline in the foreign exchange reserve in the current fiscal year. The most important factor, however, was the maintenance of unrealistic exchange rate. Again, the government is determined to maintain the same exchange rate that was in use, to the best of my knowledge, in the Panchayat period.

For the general public, myself included, the critical issue is the loan against the security of land and buildings which, as indicated earlier, is 60 percent of the total since the past several years. Now, for the commercial banks, the central bank has capped the investment limit for the realty sector at 40 percent of the total loan portfolio by 2012/13 informing the public at the same time that only two banks out of 27 banks have crossed the 40 percent exposure limit (Republica, Dec 19). It looks somewhat strange. Firstly, if only two banks have crossed the exposure limit, why such a big issue? Secondly, how did Nepal Rastra Bank calculate the loan to the so-called realty sector as the information made available to the general public shows the concentration of loan of the banking system against the security of land and buildings to 60 percent of the total. (Monthly Economic Report of the Nepal Rastra Bank, various issues) It appears that the officials of the Ministry of Finance and the central bank have unnecessarily magnified the problem, and still no new measures, except those designed to maintain the current exchange rate, have been undertaken.

The financial problems, by nature, can deteriorate at a rapid rate as the current experiences of the developed countries and that of East Asian countries in the nineties suggest. In Nepal’s case, when the situation gets worse, the concerned ministers may use the occasion for world tours in the name of looking for foreign employment for our young boys. International migration, however, cannot solve domestic problems, and a paper by the staff of the International Monetary Fund as early as 2006 shows that remittances cannot be , and never have been, used as substitute for capital flows or foreign investment. Now is the time to change the direction of the economy with priority on domestic employment and production rather than on foreign employment and remittances. The central bank should start lending a hand to job creation.

The political parties have not yet felt the need to take initiative in the area of economic management. Let us hope that they will change the direction soon. If the politicians refuse to learn from the history of the present crisis, to reuse the term once made popular by Paul Krugman, they will condemn all of us to repeat it