Nepal: a high altitude liquidity crunch

Nepal: a high altitude liquidity crunch
Financial Times, 17-May-2010
By James Lamont

One of the most striking things about Kathmandu, Nepal’s capital, is its real estate sector. Construction is rampant on the city’s edges as new suburbs push out towards the surrounding Himalayan mountains.

Teams of workers atop wooden scaffolding are transforming this ancient city, not so long ago the seat of a Hindu king, with three storey residential homes. So great is the boom in property that imported building materials are a big share in the mountain republic’s balance of payments.

And now the country’s banks are on a crisis footing.

The expansion, and sharply rising property prices, is not a sign of a healthy economy. The construction boom is fed by remittances by Nepalese workers sending money home from countries like Qatar, Malaysia and Thailand. These represent 22 per cent of GDP, and probably much more since only 1 per cent of remittances from neighbouring India go through official channels.

Much of these capital flows are by-passing Nepal’s banking system. Concerns over political instability, and the prospect of a Maoist-led government, have encouraged a flight to safety as economic growth falls. Likewise, a desire to avoid paying tax encourages a large informal economy of undeclared earnings.

Nepalese rather than putting their earnings in bank accounts are building houses, buying gold and depositing money in Indian bank accounts where they earn higher interest.

Nepal’s financial regulators are worried by the trend. They say the country’s banks are facing a severe liquidity crunch. They are encouraging local banks to offer more attractive savings rates to raise deposits and avert failure. Of particular worry is the number of banks for a small nation of about 23m people. There are 26 in total and many are owned by wealthy families with other business interests. As worrying is the proliferation of largely unregulated savings cooperatives about which much less is known.

Nepal is, of course, a long way from New York and on the fringes of the world’s financial system. It usually takes its economic cues from India, which sidestepped the global financial crisis thanks to its conservative regulatory approach. Nonetheless, two years after the fall of Lehman Brothers, Nepal stands on the threshold of its own banking crisis.

Yuva Raj Khatiwada, governor of Nepal’s central bank, has been in the job only two months and identifies bringing liquidity from the economy into the banking system as his top priority.

He has a mountain to climb, and knows it.

“Nepalese have the tradition of learning lessons late. We don’t have the habit of pro-activeness and even if we do react we do it in a belated way,” he says.