Central Bank Postpones Long-Term Liquidity Withdrawal Plan Amid Election Uncertainty

 Kathmandu. The central bank, which had moved to withdraw liquidity for the long term under the assumption that interest rates would not rise immediately, has postponed this plan. The plan to withdraw liquidity for a longer period has been temporarily shelved in view of the possibility of increased demand for loans.

Dilli Ram Pokharel, Executive Director at the Monetary Management Department of Nepal Rastra Bank (NRB), stated that the issuance of long-term bonds has been postponed because the formation of a new government after the elections might create a new market psychology, potentially increasing loan demand from the private sector. For now, the central bank will continue to withdraw liquidity through the deposit collection rate until the elections.

Previously, in the month of Poush, the central bank had adopted a policy to issue long-term bonds. Following this, the government issued long-term bonds worth NPR 200 billion in the second half of Poush. The one-year maturity bonds were sold in 9 tranches from Poush 14 to Poush 30. However, no bonds were sold in Magh. Executive Director Pokharel stated that this situation will continue in Falgun, with the focus shifting to short-term deposit collection instead.

In Magh, the central bank absorbed a total liquidity of NPR 220 billion. Some of these deposits have a maturity of one and a half months, and others are for two months. The central bank issues such instruments to keep the short-term interest rate at the lower limit of the interest rate corridor.

Currently, the NRB maintains an interest rate corridor between 2.75 percent and 5.75 percent. Accordingly, the NRB will absorb any amount of funds at the 2.75 percent rate to prevent the interbank interest rate from falling below it. Conversely, if the interest rate exceeds 5.75 percent, the central bank will lend any amount to banks and financial institutions at this rate, which helps control the market interest rate.

• Election Spending and Psychology Expected to Increase Demand

There are primarily three reasons why the central bank expects liquidity to improve now. First, potential spending due to election activities. Second, domestic debt collection at the end of the fiscal year. Third, the potential boost in morale with political stability.

It is estimated that over NPR 100 billion will be spent in the market just before the elections due to the various activities of the candidates. A large portion of this spending flows abroad, particularly for petroleum products, alcohol, and paper used for flags and pamphlets. This could put pressure on the current account surplus, which might ease liquidity management.

Second, the government collects a relatively large amount of domestic debt at the end of the year. Nearly NPR 200 billion in debt remains to be raised in the next five months. Although this amount will enter the market when spent at year-end, it can still help with liquidity management until then.

The third and main reason is morale. Due to the uncertainty over whether elections will happen, the private sector has not yet dared to undertake large investments. Central bank officials suggest that holding elections will guarantee political stability, and the new government might adopt investment-friendly policies, potentially creating loan demand in the market. The private sector might utilize the current situation if interest rates remain low. The average interest rate on loans disbursed by banks and financial institutions has now dropped to 7.12 percent.

• Nearly NPR 800 Billion in Excess Liquidity

There is currently an excess liquidity of nearly NPR 800 billion in the market. According to NRB data, as of Wednesday, the total deposits of banks and financial institutions stood at NPR 7707 billion, and the credit-to-deposit ratio was 74.35 percent.
 
According to NRB regulations, banks and financial institutions are allowed to invest up to 90 percent of their loans. This means 15.65 percent of deposits are available for lending, which amounts to NPR 1206 billion. Excluding the amount held by the central bank, the remaining amount is excess liquidity, which exceeds NPR 800 billion.
 
Executive Director Pokharel notes that although the current liquidity appears large, it will not take long to be consumed if there is a demand for large loans. Therefore, the central bank is adopting a cautious liquidity management policy, he added.

• Bank Interest Rates Still Offer Little Hope

While the central bank anticipates an improvement in market liquidity, the banking sector remains less optimistic. Banks continue to lower deposit interest rates.

On Thursday alone, 8 banks reduced their interest rates. These banks have set new interest rates for Falgun by lowering the rates for both individual and institutional fixed deposits. The maximum deposit interest rate in banks has now dropped to 5.1 percent.

Furthermore, the weighted average interest rate as of the end of Poush has fallen to 3.56 percent. The average interest rate for savings accounts is 3.92 percent, and for fixed deposits, it is 5.24 percent.