Nepal has Balance of Payment (BoP) Problem?

Commentary by NepaliEconomy.com
By NepaliEconomy.com

The most interesting economic news from Nepal late last year and early this year has been country's growing imbalance in its balance of payment (BoP). Somehow this BoP problem has manifested itself into a liquidity crisis in the banking system; essentially Nepal's banks are running out of hard cash. The scarcity of money has led to a jump in "price of money"; according to news outlets inter-bank rate has jumped to as high as 15%. Nepal Rastra Bank (NRB), the country's central bank and the lender of the last resort has responded by flooding the banking system with liquidity, in tune of Rs 15 billion, through repos (repurchase agreements) and through outright purchase of government securities. The latest action was initiated just last week in the amount of Rs 5 billion (story: NRB to inject additional Rs 5 billion). We are not sure if that has worked or will work.

So what exactly is Balance of Payment (BoP)? BoP tracks the amount of money going out of the country called "debit" (paying for imports of goods and services, repatriation of income by foreigners and purchase of foreign assets) and coming into the country called "credit" (getting paid for exports of goods and services, income from foreign assets, foreign aid, remittances and selling of foreign assets or domestic assets to foreigners). In economic parlance, debit must equal credit or Balance of Payment must balance but how it does is the more important question.

To answer the how question, it is important to look at BoP from "flow" and "stock" prospective. The flow part of BoP is called Current Account (CuA). It includes money flows due to trade, income from assets and unilateral transfers (remittances and foreign aid). The "stock" part of BoP is called Capital Account (CaA). It includes transfer of money due purchases and sales of assets which can be divided into financial and non-financial assets, and government and non-government assets. For BoP to balance CuA must equal CaA. Ideally countries like Nepal ought to have CuA surplus and CaA deficit.

Until Q3 of 2009, Nepal had growing CuA surplus mainly because remittances offset rising trade deficit. That meant Nepal had huge CaA deficit in the form of ballooning foreign exchange reserve. But global recession hit in 2009 which affected destinations for Nepalese migrant workers; namely Malaysia and Dubai. Remittances to Nepal started to slow down in Q4 (this is a guess because we do not have a hard data). The immediate impact was on Nepal's banks’ liquidity. Hitherto, Nepal's banks acted as the intermediaries between remittances and domestic investment. Of course not all foreign money could be used for investment and the surplus provided the liquidity needs of the banks. When remittances slowed down and trade deficit did not, flow of foreign money suddenly dried up at Nepal's financial institutions and caused liquidity crisis.

Going forward if remittances continue to trend down, Nepal has to find ways to offset that by narrowing its trade deficit. And that means addressing trade issues with India. In the latest quarter (2008/09 Q3) Nepal had Rs 50 billion trade deficit, of that Rs 30 billion was with India. May be an over-due devaluation with Indian Rs is in order.