Banking Reforms Crucial for Nepal to Address Credit Rise: IMF

In a bid to improve Nepal’s alarming credit scenario, the International Monetary Fund (IMF) directed the country to fast-track its banking sector reforms.

The international body stated this in view of the rising credit in Nepal banking sector provisions pertaining to loan classification, loan-loss provisioning and risk management.

“Rapid credit growth underscores the need to accelerate banking sector reforms. Loan classification, provisioning, and banks’ risk management practices should be upgraded,” says IMF’s latest South Asia Regional Update.

Nepal’s Deteriorating Credit Scenario
Nepal’s loose monetary policy and mandatory central bank requirement of four-fold rise in paid-up capital of commercial banks has triggered rapid credit expansion. Besides this, the private sector’s low lending growth at an average 22 percent in the last two years has resulted in this scenario.

A big chunk of credit continues to enter these sectors despite the central bank’s attempts to curb the flow of credit to unproductive sectors through revision of loan-to-value ratio on car and real estate loans.

IMF suggested that credit expansion take place in a sustainable manner. However, this could hit the country’s economic growth.

Nepal’s Economic Performance
In the last two years, Nepali economy has made rapid progress with the growth rate standing at eight percent in FY 2016-17 and 6.3 percent in FY 2017-18.

“Above-trend growth has been supported by two successive favorable monsoon seasons, accommodative fiscal and monetary policy, a pickup in [post-earthquake] reconstruction activity, and markedly improved electricity supply,” reports IMF.

However, expansions policies that triggered growth have also fueled imports. This has resulted in a current account deficit of 8.2 percent of GDP in 2017-18. 

The deficit further caused the central bank foreign exchanges to shrink to USD 9.7 billion in September 2018 from USD 10.1 million in July, 2018.

Furthermore, the growing current account deficit also burdens the budgetary operations of the government with a fiscal deficit of more than six percent GDP in 2017-18.

This deficit further widened with large transfers to local governments and rise in capital spending. Following this, public debt rose to a manageable 29.7 percent of GDP.

“The fiscal deficit could widen further in 2018-19 with the ongoing implementation of fiscal decentralization, unless the government continues the strong revenue collection effort seen in the first two months of this fiscal year when revenues rose by 36 per cent year-on-year,” states the IMF report.

The Way Forward
According to IMF, Nepal’s near-term challenges include:

• Maintaining the recent growth momentum
• Creating conditions for sustained high and inclusive growth

“Efforts should focus on strengthening key institutions and administrative capacity to boost private investment and growth,” reports IMF.

“Fiscal policy should focus on higher and better-quality public investment and prudent implementation of fiscal decentralization through sustainable intergovernmental fiscal arrangements and the need to build public financial management capacity at the sub-national level,” it adds.

IMF warns that hasty implementation of fiscal decentralization could strain government finances and weaken fiscal policy’s stabilization function.

“At the same time, with the fiscal stance having become more expansionary than in previous years, monetary policy needs to be tightened to keep inflation and balance of payments pressures in check,” says the IMF report.