Swelling liquidity: Challenge or opportunity?

----------Analysis-------------- PRABHAKAR GHIMIRE KATHMANDU, Dec 6: Private sector representatives met with top leaders of major political parties before and after the election for the Constituent Assembly (CA) with a key demand -- restoration of business climate in country. Just ahead of the election, the Federation of Nepalese Chambers of Commerce and Industry (FNCCI), the private sector´s representative body, urged the political parties to prioritize economic agenda in their election manifestos. Office bearers of FNCCI met Nepali Congress President Sushil Koirala, CPN-UML Chairman Jhalanath Khanal and RPP-Nepal Chairman Kamal Thapa seeking their roles for business-friendly environment in the country. Election manifestoes of all political parties were flooded with commitments to restore the investment climate. However, the private sector is still not confident about the prospects for investment even after the successful holding of the election. “As the election is just over, we have to watch the political situation that will unfold in the coming days before jumping into making decisions about fresh investment. Though the demand for loans at the banks is negligible these days, we are hopeful that the situation will be restored for more investment,” Pashupati Murarka, a vice-president of FNCCI, told Republica. Though entrepreneurs are excited with the successful completion of the elections, they are still on a ´wait and see´ mode for new investment. They are not only closely watching the political development and aftermath but also lobbying with top leaders for better environment for investment. Concerns expressed by private sector leaders over the investment climate and excessive liquidity in the market shows that investors are still not confident enough that the situation will get better in the country for doing business. Demand for loan has not picked up even after the election, leaving liquidity in the banking system at Rs 70 billion, an indication that the private sector is still indecisive on whether to invest or not. “As demand for loan has remained almost stagnant, liquidity worth over Rs 70 billion has piled up in the banking system,” said Upendra Poudel, the vice-president of Nepal Bankers´ Association (NBA). Private sector leaders have long been voicing their concerns to the political parties over pertinent economic issues such as better climate for investment, deficit of development infrastructure, widening trade deficit, deepening unemployment, worsening industrial climate, deficit of power and political instability. “We are hopeful that political parties will show their seriousness in dealing with the burning economic issues. We need political stability and favorable business environment for better economic performance,” Murarka said. Murarka said the private sector can take advantage from a lowering of interest rates with the voluminous liquidity. “Liquidity rise has brought down interest rates. That will be an opportunity for investors if the business climate is restored,” Murarka added. Nepal Rastra Bank (NRB), the central bank, has said that commercial banks invested loans worth around Rs 35 billion while deposit collection crossed Rs 59 billion since the beginning of the current fiscal year. Total deposits with commercial banks stands at Rs 1,075 billion while loan investment hovers at around Rs 789 billion. NRB has already used its monetary instruments to reduce liquidity to stabilize the banking system. Negligible progress in loan investment and rising inflow of money into banks due to huge spending during the election jacked up liquidity. Responding to bloating liquidity, banks have decreased interest rates on deposits to around 4-5 percent from up to 7-9 percent. Interest on lending has also declined to around 10-12 percent. During the height of a liquidity crisis a couple of years ago, interest on loans was as high as 16 percent. A liberal policy taken by NRB on issuing loans for purchase of shares and properties, and reduction of the Cash Reserve Ratio (CRR) for banks have also driven up liquidity. In the current monetary policy, NRB brought down CRR by one percentage point to 5 percent, 4.5 percent and 4 percent for Class ´A,´ Class ´B´ and Class ´C´ financial institutions respectively. Liquidity swelled as government spending couldn´t go up as expected despite timely announcement of a full-fledged budget followed by authorization for spending by different government agencies. However, the government couldn´t increase capital spending at the desired level until the end of the first four and a half months of the current fiscal year. “Economic activities have slowed in the absence of public and private investment, which are the biggest stimulator for growth. Sluggish capital spending is set to hamper growth this year,” Keshav Acharya, former Chief Economic Advisor at the Ministry of Finance, said. In the current budget, the government has announce a growth target of 5.5 percent, with the expectation of a better farm harvest and increased economic activities due to timely announcement of budget. However, depending on only the agriculture sector, which commands more than one-third of the total Gross Domestic Product (GDP), can´t push up growth given the slowing in industrial sector. Contribution of the industrial sector, which commands around 15 percent of total GDP, is going down, due to frequent labor unrest, shortage of skilled human resource, political instability and deepening shortage of power. Employment generation, which is also an indictor of performance of any economy, has also been affected due to lack of new investment in productive sectors. At least 1,500 youth are making their way to overseas in search of jobs pushed by crunch employment opportunities within the country. According to rough estimates, at least 450,000 new youths enter the domestic job market in search of employment every year. A recent macro-economic report from NRB shows that year-on-year inflation during the month ending mid-October stood at 8.4 percent. The government has set a target of containing inflation to 8 percent for the current fiscal year. Ram Saran Pudasaini, the joint secretary at MoF, also agreed with the fact that capital expenditure couldn´t be increased as planned during the first five and a half months of the current fiscal year due to major festivals and ten days of nation-wide shutdown followed by the CA election. “Capital expenditure didn´t rise as expected because we took five and a half months to approve programs, authorize the spending and contract process for new projects though we announced the annual budget in time. We could initiate implementation of only those projects which had been under implementation from previous years,” said Pudasaini. Inter-bank lending has also come down to a nominal 0.2 percent, which is significantly low compared to the previous year. In a bid to mop up the swelling liquidity, the central bank has already drawn over Rs 73 billion through reverse repos and other monetary instruments. Devaluation of the Nepali currency by around 20 percent compared to last year has increased the flow of money in the market. “Investors are hesitating in making new investment as they are not still confident that the county´s politics will take a positive turn in the coming days. Around Rs 50 billion of excess liquidity has piled up in the banking system,” said Acharya, who is also former chief of Research Department at NRB. Decreasing interest for deposit offered by banks in response to the excess liquidity will encourage capital flight in search of better returns. “The rate of return on deposits has gone down which will discourage deposits and stimulate capital flight as banks at trans-border markets are offering at least a 9 percent return,” said Acharya. However, Acharya sees a positive impact from declining interest rates on deposit for the capital market. “As investors can get loans at a cheaper rate and increase investment in the capital market where they can find higher rates of return than banks are offering on deposits,” said Acharya. The recent bullish trend in stock market has been attributed to declining bank interest rates and expectation of positive political course. The Nepal Stock Exchange (Nepse) index closed at a five-year high of 707.41 points on Thursday – the last day of the week´s trading. Reducing CRR for banks and increasing capital spending by the government will support by mopping up liquidity in the banking system. “The private sector will be encouraged to spend if government spending goes up,” added Acharya.
Published on 2013-12-06 03:00:51