Kathmandu University School of management

Balkumari, Lalitpur

Nepali Economy

Policy Review
Monetary Policy 2019/20

Submitted by:
Jeevan Regmi
Roll no. 18781
BBA Year II Semester IV
Group A

Submitted to:
Ms. Anupana S. Pant
Nepali Economics

Date: April 14, 2020

Table of Contents

INTRODUCTION OF THE POLICY 4

SUMMARY OF THE POLICY: 4

PROS OF POLICY: 5
INVESTMENT IN THE ECONOMY: 5
INCREASE IN THE NATIONAL INCOME/REAL GDP 8

CONS OF POLICY: 11
DEBT TRAP: 11
INFLATIONARY PRESSURE: 12

EFFECTIVENESS OF POLICY 14
CENTRAL BANK WILL HAVE MORE CONTROL ON MONEY IF COMMERCIAL BANKS ISSUE DEBENTURES 14
INCREASING TREND OF ECONOMIC ACTIVITIES IN THE IN THE COMING YEARS FULFILLED BY LIQUIDITY INFUSION BY NRB
SEEMS EFFECTIVE 16
REDUCED INTEREST RATE CORRIDOR KEEPS INFLATION IN CHECK: 16

INEFFECTIVENESS OF POLICY 17
EXPANSIONARY NATURE OF POLICY LEADING TO AN OVERHEATING OF THE ECONOMY: 17
DECREASE IN LRAS: 17
COVID19 HAS HIT THE REMITTANCE AND TOURISM FURTHER MAKES THE POLICY INEFFECTIVE 18

SOLUTIONS 19
INCREASE IN AGGREGATE SUPPLY 19
DEBT SHOULD BE USED IN THOSE PRODUCTIVE SECTORS WHERE RETURN COME FAST 20
EXPANSIONARY MONETARY POLICY TO SUPPLY MONEY IN THE ECONOMY TO MEET CONSUMPTION OF HOUSEHOLD AND
FIRMS THAT IS DISTURBED BY COVID19 21

MANAGERIAL IMPLICATIONS: 21

REFERENCES: 22

HONOR CODE: 22
INTRODUCTION OF THE POLICY
Monetary Policy is the policy adopted by the monetary authority of the country that controls the
overall interest rate, supply of money to ensure price stability and sustainable socio-economic
growth. In Nepal, monetary policy of Nepal Rastra Bank (NRB) is intended to manage the
supply of money in various sectors of the economy as per their need. Nepal Rastra Bank (NRB)
has been formulating and publicly announcing monetary policy on the annual basis since 2002.
In addition, it has been releasing half-yearly review of the policy since 2004/05 and quarterly
review since 2016/2017. AS directed by the NRB act, 2002, the policies majorly aim to maintain
price stability and external as well as financial sector stability and to create a favorable
environment for high sustainable economic growth.
Monetary policies basically increases or decreases the liquidity to create economic growth or to
prevent high inflation. Central banks use interest rates, banks’ reserve requirements and the
number of government bonds that banks must hold. These basic tools affect the bank lending and
hence the volume of loans affects the money supply. In this way monetary policy plays a
stabilizing role in influencing economic growth through the number of the channels.
The government of Nepal has been formulating the monetary policies after the budget
announcement in order to fulfill the provisions relating to the financial sector as specified in the
budget. As, high inflation is damaging to long-run economic performance and welfare, the
monetary policies has far reaching impact on the financing conditions as maintaining the price
stability.
The policy review of the Monetary Policy for 2019/20 has given insights to us students as to how
NRB should have keen eye on different sectors of economy to attain the goals set up by the
government of Nepal (GoN), Fifteenth plan as well as the sustainable development goals to be
attained by 2030. Monetary policy for 2019/20 has been formulated considering the domestic
and international economic developments along with the programs outlined in the budget of the
government of Nepal (GoN) for 2019/20.

SUMMARY OF THE POLICY:

The Comprehensive Review of monetary Policy for 2019-2020 covers the major subjects of the
policies such as introduction consists of basic definition and its significance, how this monetary
policy impacts on the Nepalese economy, the major pros and cons; effectiveness as well the the
ineffectiveness, some recommendation for improvement and the managerial implication. The
monetary policy ensures an efficient operation of the economic system majorly through up and
down of policy rate which will in turn bring changes in rate of interbank lending market,
money market interest rate, long term interest rates, which will eventually help to achieve
the required inflation and price stability leading to the price stability and economic growth.
While in the developed countries monetary policies are functioned as stabilizing and
maintaining proper equilibrium in the economic system, in an underdeveloped country like
Nepal, the monetary policies are more focused in order to meet the requirements of an expanding
economy by creating better circumstances for economic progress.
The monetary policy aims to provide proper economic functioning by Consolidation of the BFIs
to enhance their ability to mobilize resources and increase the access of the general public to
financial services; Stability of exchange rate and interest rate through effective liquidity
management; Price stability by maintaining monetary aggregates at the desired level
Increase domestic production, employment generation and entrepreneurship development;
Economic Growth through increase on external sector stability; Equilibrium in the Balance of
Payments
The policy has a basic substructure for an effective implementation; it has been divided into four
parts as: Monetary policy framework for 2019/20, financial sector program for 2019/20,
Strengthening Payment system and Foreign Exchange Management.
Monetary policy framework for 2019/20.
It has been designed with accordance to the current economic system and focuses on the part of
the economic enhancement in the country.
It focus on containing consumer price inflation, ensuring external sector stability, to facilitate
the economic growth of around 8.5 percent and domestic credit & private sector credit growth.
The policy focuses on the credit and loans facilities to be provided to the people in order to
increase investment and the optimal resources management for the effectiveness in economic
growth.
For Financial Sector Strengthening, the policy focuses on the proper systemized and monetarized
financial sector.
For the well-functioning of financial institutes the policy enhances MFIs to mobilize and
establish in different sectors economy of the nation.
The policy initiates the payment system to be systemized and digitalized so that the services
could be enhanced in rural areas through mobile phones.
The policy will be focusing on the proper foreign exchanges, investment, currency transactions
management, so that the country could have positive balance of payment.

PROS OF POLICY:
Investment in the economy:
The ultimate goal of the monetary policy is to lead an economy to the level of expected
economic growth through investment in various sectors. The pros of such monetary policy
can be seen in the rise in the level of national income or the Aggregate Demand. Investment
Multiplier takes place in an economy. For instance, we have the policy to encourage Bank
and Financial Institutions in mobilizing financial resources through the issuance of
debentures. This has contributed to the development of bond market and the investment
culture among the Nepalese people as debentures are safer way of investing. Investment in
any sector in the economy plays a multiplier effect leading to larger macro-economic impact.
The investment multiplier effect can be seen in the figure below:

Fig: Multiplier effect of investment in Nepali Economy

The x-axis shows the National Income of Nepal and the y-axis depicts Aggregate Demand.
When the Investment is done in the economy the aggregate demand shifts from AD to AD1
because investment is one of the contributing components of Aggregate Demand. When the AD
shifts upward, the national income increases from Y1 to Y2. The increase in national income
increases the per-capita income of the people of Nepal as they are earning higher income.
We know that, the Marginal Propensity to Consume (MPC) is higher in developing countries.
Once people are earning higher income, their level of consumption also increases. With the
increase in the level of demand AD further shifts upward. There is economic growth happening
in the nation. The gradual shift of AD is shown below:

Fig: Shift in AD due to the impact of consumption and investment

The living standard of Nepalese people also increases due to investment in other sectors. They
receive better health care facilities, education, infrastructures as well as skills due to investment
in sectors such as hospitals, schools, roads, vocational programs respectively. The Human
Development Index (HDI) of people prospers. The virtuous cycle of poverty takes place.

Fig: An example of virtuous cycle due to public investment When people of Nepal learn new
skills and use them practically for the upliftment of the economy, the level of income inequality
also reduces. People below poverty line get employed, they start earning, and they consume and
further might as well invest. This nature is shown in the Lorenz curve as follows:
Fig: Lorenz Curve
These effects shows that the impact of debentures issued by BFIs in the economy. Such
investment in the public sector can act as a multiplier and lead to overall socio-economic growth.

Increase in the national income/real GDP

The monetary policy has focused on a lot of sectors which can help in the increase in investment
in our country. Policy 49 states, “The total number of branches of the BFIs reached 8564 in mid-
June 2019, which comprise 3539 branches of commercial banks, 1250 branches of development
banks, 205 branches of finance companies and 3570 branches of MFIs. The total number of
branches of the BFIs was 6414 in mid-June 2018.” This results in increased facilities which
accelerates the procedures and makes the process of investment easy. Policy 60 states,
“Monetary policy will focus on interest rate stability through effective liquidity management.”
This assures the investors that the risk or loss is minimized which increases the investment.
Policy 98 states, “For agriculture, enterprise and business promotion loan up to Rs. 1.5 million,
BFIs will not be allowed to charge interest exceeding 2 percentage points above the base rate and
take any service fee or loan prepayment charges from the borrowers. Also, each branch of the
BFIs will be required to approve such loan within seven days. In case the application is rejected,
the applicant should be informed about the rejection with clear reasons.” This again encourages
the investors. Increase in investment will result in increase in AD due to their direct relationship.
AD = C + I + G + (X – M)
As seen in the graph above, increase in investment resulted in shift in IS curve from IS1 to IS2.
But, the product market does not work alone in an economy, money market works side by side.
When people invest, they get higher returns; the economy develops and so on. People get more
opportunities and their income rises as well. Increase in income means increase in money
demand in an economy. The central bank keeps money supply constant in short run, so when the
money demand increases, there is movement in LM curve.
As shown in the above graph, the increase in money demand has led to increase in interest rate
and movement in the LM curve. Along with this, the policy also states that it will maintain its
broad money supply at 18% which will enable the money supply to shift causing a rightwards
shift in the LM curve which can figuratively be represented as:

This shift of the LM curve will dissolve the crowding out effect that may arise due to the
increase in the GDP of the country and subsequently increase the national income to its full
potential to Y*; still maintaining a stable rate at i*.
CONS OF POLICY:
Debt Trap:
As mentioned in the monetary policy, policy 78 states, “Sources of foreign borrowing for the
BFIs will be further expanded. A provision will be made for the BFIs to borrow from foreign
pension fund, hedge fund and similar other sources, in addition from the banks. Also the areas
for the utilization of such fund will be broadened.” Also, policy 79 states, “The maximum
interest rate to be paid by the BFIs on the borrowing in convertible currencies will be set at 6-
month LIBOR plus 4 percentage points from the existing 6-month LIBOR plus 3 percentage
points.” Here we can see that policy is made in favor of foreign borrowing. This can lead our
country to debt trap. A debt trap is a situation in which a borrower is led into a cycle of re-
borrowing, or rolling over, their loan payments because they are unable to afford the scheduled
payments on the principal of a loan. These traps are usually caused by high-interest rates and
short terms. When Nepal borrows from foreign countries, being a developing nation, it will be
very hard to pay the loan back. To even pay the interest of debt of one nation, we again have to
borrow from another nation. This results in the debt trap. The government spending is then
wasted in paying the debt. When government spending decreases, the infrastructures cannot
develop as well. This can result in negative multiplier effect. The negative multiplier effect
occurs when an initial withdrawal of spending from the economy leads to knock-on effects and a
bigger final fall in real GDP. When government cannot spend in developing the infrastructures,
the other components of GDP is also affected. So, a small decrease in government spending will
result in huge loss of real GDP. Figuratively,

As shown in the figure above, the AD has decreased from AD1 to AD3 as a result of negative
multiplier effect. This results in decrease in real output from Y to Y2. Hence, this is a
disadvantage of the policy.

Inflationary pressure:
The Monetary Policy 2019/20 adds to the inflationary pressure to some extent. A decrease in the
bank rate helps the banks to increase the money supply in the economy which increases the
consumer spending and decreases the rate of interest encouraging lending and investment in the
goods market as people borrow more money at a low rate of interest. The increase in the private
consumption and investment results in the upward shift in the aggregate demand curve. The
upward shift in the aggregate demand curve increases the national income along with an increase
in the price level resulting into demand pull inflation.

This demand-pull inflation can further lead to cost push inflation. As the price increases the
purchasing power of the workers decreases so the workers demand more wages to compensate
them for the higher cost of living which leads to a rise in the wages. Increase in wages increases
the cost of production. The employers start cutting off employees to reduce their cost of
production which leads to a decrease in the aggregate supply leading to a leftward shift in the
aggregate supply curve.

The leftward shift in the supply curve again leads to a rise in the price which results into cost
push inflation. Thus, this policy leads to higher economic growth along with the higher inflation.
EFFECTIVENESS OF POLICY
Central bank will have more control on money if Commercial banks
issue debentures
The Policy has mandated commercial banks to issue debentures equivalent to 25% of their paid-
up capital by mid-July 2020.
The logic of the expectations theory suggests that the long term bond rates tend to gravitate
toward market expectations of the average future path of short term interest rates which can be
easily manipulated by the central bank through interest rate corridor. So, if government asks
commercial banks to issue more of such long term bonds and debentures; central bank will have
more grip on the economic activities.

in the above figure forst by bringing changes in the policy rate central bank gets the desired
money market interest rate, which is actually the base for the interest rate expectations for the
long term bonds and debentures . Low interest rates make borrowing to finance 
housing cheaper and corporate investment more profitable. This stimulates aggregate demand, 
which in turn has a dampening effect on consumer price inflation. That's why we see that
through issuance of more long term bonds and debentures and having more control on the
interest rate of such long term securities central bank becomes able to reduce or increase the
output gap in the desirable .
Due to the increased credit disbursement by the commercial banks, the investment multiplier has
come into action. This is because an injection of extra income leads to more spending, which
creates more income, and so on. The multiplier effect refers to the increase in final income
arising from any new injection of spending. The larger an investment multiplier, the more
efficient it is in creating and distributing wealth throughout the economy. Hence, in the above
diagram Y=C+S is the aggregate supply curve whereas C+I is the aggregate demand curve. So
with an increase in availability of credit, there is an increase in investment within the economy as
a result there is more employment for all the people in that nation. With an increase in
employment, the demand cure shifts outward to C1+I1 and there is a significant increase is
consumption and spending as well by the people which will eventually lead to in an increase in
National income from Y to Y1.
Increasing trend of Economic activities in the in the coming years
fulfilled by liquidity infusion by NRB seems effective

Liquidity in the banking sector during FY2019 shows the increasing liquidity infusion trend. The
liquidity infusion has increased progressively over the last three years with NPR 123 billion in
FY2017, NPR 146 billion in FY2018 and NPR 322 billion in FY2019 as compared to the
minimal infusion before FY2017 (NPR 10-15 billion).
With the increasing interbank transaction and ongoing liquidity shortage, the interbank lending
rate (across commercial banks) stood at 4.20% for FY2019 as against 3.54% for FY2018 and
2.60% for FY2017.
liquidity infusion includes all monetary measures including repo, standing liquidity facility and
outright purchase

Hence by the rise in economic activities and the sharp rise in liquidity infusion has making the
credit available more easily shows the effectiveness of monitary policy (also in the coming days)

Reduced interest rate corridor keeps inflation in check:

The monetary policy has introduced the interest rate corridor for the first time in Nepal. This
provision is beneficial to both depositors and loan clients. The interest rate corridor is a
mechanism that guides short-term market rates and helps keep all interest rates in a certain band,
thus curbing volatility of interest rates. With the introduction of this mechanism, depositors will
not have to grouse about low interest, while loan clients will not have to worry about high
interest. Also, it provides certainty to all the investors willing to invest. Overall, the monetary
policy is expected to bring about stability in the financial sector by introducing some reformatory
measures. Thus, the interest rate corridor has the following features
Rates under the interest rate corridor have further been constrained to 3% to 6% (earlier 3.5% to
6.5%) with means to provide more stability to short-term interest rates. The upper bound rate in
the corridor is the standing liquidity facility rate while the lower bound rate signifies the two
weeks’ deposit collection rate. The Policy rate has also been decreased to 4.5% from 5%, which
is two weeks’ repo rate. Thus the NRB plans to make the interest rate corridor more effective to
address the short-term interest rate volatility.

INEFFECTIVENESS OF POLICY
Expansionary nature of policy leading to an overheating of the
economy:
The policy envisions broad money supply growth of 18.0% and an internal credit growth of
24.0%. To support this high credit growth, NRB has cut both bank and floor rates by 50 basis
points each. It has allowed BFIs to borrow foreign loans from banks and other sources like
pension and hedge funds. The BFIs can further mobilize fixed deposits in foreign currencies
from foreign institutional depositors and non-resident Nepalese. This amount can then be fully
injected in Nepali currency into the local economy. If higher credit infusion is absorbed by
tradable sector, this will have a high fiscal multiplier effect. But if more credit is infused in real
estate, working capital and overdraft, this will trigger financial risk and instability. Data to mid-
June 2019 suggests that BFIs lending to real estate, working capital and overdraft constitute
42.2% of their total lending, equivalent to 38.2% of GDP. This accommodative Monetary Policy
combined with the expansionary Fiscal Policy may build pressure on prices and external
stability.

Decrease in LRAS:
The monetary policy has made it compulsory for banks to invest at least three per cent of their
total staff expense on training and career development. The objective of this provision was to
produce skilled human resources. It is a good provision. But what should be kept in mind is that
spending money on training and career development just for the sake of training and career
development will not churn out the desired results. So banks have in hesitant to invest in such
unproductive training and other activities to ensure that their money is not squandered.
Similarly, although the percentage of deprived-sector lending has not been changed, the
monetary policy has changed the pattern of lending. As per the new provision, banks are required
to directly invest at least two per cent of their total loan portfolio in the deprived sector and the
remaining three per cent of the loans may be made through microfinance institutions. Till now,
banks had been providing five per cent of their total loans to microfinance institutions, micro-
hydropower companies, cooperatives and other institutions that, in turn, made loans in the
deprived sector.
Thus, banks have definitely found it heavy going to make direct investments in the deprived
sector as they will have to go to the rural areas (deprived groups are mostly concentrated there)
and take the initiative of finding out underprivileged groups who need the loans to improve their
life. Since two per cent of the total loans have been made directly by the banks, the loans of
microfinance companies engaged in deprived-sector lending will be affected, resulting in lower
profit. 
Besides, banks are also unwillingly to step into the jurisdiction of microfinance institutions,
which have come into existence for the purpose of uplifting the deprived communities through
privileged lending. Further, banks are having to divert at least two per cent of their total loans
from microfinance companies to underprivileged groups, which is not an easy proposition given
their infrastructure, branch networks and manpower. 

Hence all of the above mentioned factors would discourage the firms and as a result the long run
supply curve shifts to the left from LRAS to LRAS1 which further increases the price from p to
p1.

Covid19 has hit the remittance and tourism further makes the policy
ineffective
We know that the policy focused on promoting tourism. The policy 144 states, “In view of the
Visit Nepal Year 2020, arrangements will be made for the BFIs to open separate foreign
currency exchange counter facilities at major tourist destinations.” But due to the fact that
Covid19 outbreak as a pandemic, the tourism seemed impossible. Covid19 has hit the
remittance and tourism may causes depreciation of Nepalese currency since we are hugely
import based country.
“Nepal's economy is estimated to grow at 6.5 percent in this fiscal year 2019-20, way below the
ambitious 8.5 percent target set by the government, according to the World Bank. The World
Bank said in its report entitled South Asia Economic Focus published on Sunday that the gross
domestic product growth rate was forecast to reach 7.1 percent in 2019 and 6.4 percent in
2020.”
Source: The Kathmandu Post, October 2019

Service industries like tourism and hotels are being hit especially hard. Tourism was expected to
drive Nepal’s economic growth and contribute greatly to the high growth target of 8.5 percent
that the government had set for this year, but this industry tends to have little financial cushion.
The contribution of the tourism sector to Nepal’s economy stood at 7.9 percent in 2018,
according to the report prepared by the World Travel and Tourism Council, which represents the
private tourism industry and counts more than 200 company members.
It is a tourist season but there is very low occupancy of hotels in major tourist hubs like Pokhara,
Thamel, Bandipur, and Chitwan. For Nepal, India is the largest source of tourism industry
followed by China and the United States.

Given travel restrictions around the world and a fall in Chinese imports, tourism, manufacturing
and remittance are all expected to see a slump. https://tkpo.st/2wuoZFr

Nepal has a negative balance of payment. Major source of currency inflows were tourism and
remittance only coming next we can face a huge deficit in balance of payment causing value of
Nepalese currency to depreciate. We may have to buy foreign goods by giving more of our
currency that we are currently paying since we are no so much of a productive country our
imports are going to be less hence we will not be benefited so much by being able to sell more
in foreign market.

SOLUTIONS
Increase in aggregate supply
Demand side and supply side economics go hand-in-hand. So, we must not neglect the supply
side policies which are crucial for the economy. Supply-side policies are government attempts to
increase productivity and increase efficiency in the economy. If successful, they will shift
aggregate supply (AS) to the right and enable higher economic growth in the long-run. Supply-
side policies will increase the sustainable rate of economic growth by increasing LRAS; this
enables a higher rate of economic growth without causing inflation. The inflation rate, basically
increased in an economy when there was excess demand of goods and services due to increase in
urban population or rise in living standard. This increased demand should be backed up by
increasing the supply as well. Figuratively,
Debt should be used in those productive sectors where return come
fast
We have noticed that the policy is focusing on encouraging foreign borrowing. This can be good
for short run but in the long run, the nation’s economy will go downwards due to debt trap.
Therefore, it is necessary to be used in those productive sectors where return come fast from.
This can help in utilizing the government spending. It can be used in developing the
infrastructures and employment generating sectors. When government spending increases in
developmental works, the AD also increases due to their direct relationship. Not only this, when
development is seen in the country, the opportunities and facilities increase as well. This will
further improve the aggregate demand and result in multiplier effect.

Expansionary monetary policy to supply money in the economy to

meet consumption of household and firms that is disturbed by Covid19
We know there is a time lag between the implementation of policies and getting the
desired result. So it is perfect time to push money supply in the economy so that normal
consumption patterns don’t get hampered because if people become able to pay the
inflated price during the epidemic later on the central bank may easily decrease the
money supply after the epidemic since the consumption pattern remaining constant
during the period of epidemic.
Increase in money supply during the epidemic will help to control the future
inflation that might come in the future after the epidemic is finished. So in order to
run all the existing business smoothly as it were before epidemic, the central bank need to
take necessary steps by which household and business firms won’t feel hardship
economically now during the period of epidemic even at the cost of short term inflation
in the economy during these days of epidemic.

MANAGERIAL IMPLICATIONS:
As a manager, I understood the importance of the latest news and updated given by NRB
regarding the monetary policy. I also knew the importance of policy rates of central bank
regarding how the economy is goingb to behave in the future. So by news and updated
given by NRB we can make our investment more profitable.
REFERENCES:
Monetary Policy 2019/20 6 to 21
https://tradingeconomics.com/nepal/inflation-cpi

https://kathmandupost.com/national/2020/03/02/tourism-ministry-cancels-visit-nepal-
promotions-for-march-but-experts-say-it-is-too-little-too-late

HONOR CODE:
“On my honor as a student, I pledge that I have neither given nor received aid on this
assignment.”