Taking Nepal Out of Another Monetary Hangover
The dynamism of the financial market, currently a prominent topic of debate in Nepal due to excessive liquidity, reflects the broader macroeconomic situation. Volatility and apprehension within the money market, coupled with dwindling private sector confidence and recurring political instability, present concerning signals. If these are not addressed through appropriate policy measures, the economy will face adverse impacts.
Nepal’s Credit to Deposit (CD) ratio has remained below 80% for the last three years and continues to decline. The ratio stood at 78.89% at the end of Fiscal Year 2023/24, dropped to 75.78% by the end of 2024/25, and has fallen further to 74.32% as of March in the current Fiscal Year 2025/26. Although the Nepal Rastra Bank (NRB) permits banks and financial institutions (BFIs) a CD ratio threshold of 90%, allowing them to lend up to 90% of their deposits, BFI activity over the past few years has remained significantly below this limit, reflecting a sluggish market struggling to mobilise capital.
Nepal has maintained a moderate growth rate of 3% to 4.5% at a sub-optimal equilibrium over the last few decades. Consequently, it has been unable to recover from the post-COVID period at a natural pace, leading to market vulnerability. There was no aggressive stimulus package to support economic recovery beyond minor flexibilities in commercial loans, including those for real estate, and tax submission extensions. This reflects Nepal’s limited capabilities stemming from moderate growth, further indicated by an average investment rate of around 25% of GDP.
The sluggish post-COVID recovery, alongside externalities affecting inflation and remittances, kept the market stagnant. This was compounded when the government imposed import restrictions in 2022 due to a forex crunch, yet found no prospect for effective utilisation when forex reserves later reached record highs. While real estate saw a brief hike due to temporary flexibilities, the tight monetary policy of 2023 increased bank, policy, and deposit collection rates, which subsequently stifled growth in both the credit and real estate sectors.
Although tightening real estate to divert capital toward productive sectors is logical, tightening the entire monetary sector to control inflation was a significant miscalculation by the NRB and International Monetary Fund (IMF). In reality, the inflation at that time was driven by externalities such as the Ukraine crisis and rising petroleum prices. Thus, the 2023 policy tightening ultimately hindered growth more than it controlled inflation.
The NRB responded with a loose, expansionary monetary policy in 2024 by lowering bank and policy rates, but the market failed to react aggressively due to fears that slow growth would depress spending. Monetary decisions disconnected from economic realities, coupled with looming political uncertainties, a lack of prudent fiscal policy to increase capital expenditure, and a deficit in effective governance, continue to act as stumbling blocks to market revitalisation.
Furthermore, the physical damages caused by the November 2025 Gen-Z movement have raised doubts regarding the security of investments in Nepal. For a country striving for an economic boom, this represents a major setback. Currently, the private sector remains in a ‘wait and watch’ mode, hesitant to take further steps until assured of political stability and investment security. Despite the availability of loose monetary tools in the ensuing days, they have not been productive in mobilising the market, resulting in persistently high liquidity.
Banks and financial institutions are currently burdened with Rs. 1.2 trillion in investable capital, while the credit interest rate has reached a record low of 6.9%. Notably, the credit interest rate was 10.43% in 2019/20 and climbed to 11.94% in 2022/23 due to tight monetary policy. During that period, some institutions charged rates as high as 16%. Subsequently, the rate dropped to 10.15% in 2023/24 as loose monetary tools were adopted to mobilise the liquidity accumulating in BFIs. By 2024/25, the interest rate fell further to 8.17% to float this liquidity, yet the results have not been productive.
At present, liquidity remains at a record high and interest at a record low, but credit flow is still unimpressive. Due to the lack of demand for new loans, the NRB is raising short-term funds at low rates, paying banks a maximum interest rate of 3%.
The private sector’s ‘wait and watch’ stance is a common phenomenon during times of economic uncertainty, political transition, or policy ambiguity. It signifies a halt in new investments and expansions as businesses carefully measure associated risks before committing capital. Numerous studies have identified political instability as a major obstacle to Nepal’s economic development, as it perpetuates other uncertainties. While the Gen-Z movement took to the streets to overcome this instability, the subsequent elections formed a Rastriya Swatantra Party (RSP) government with a near two-thirds majority, which now holds the primary role in addressing these concerns. Expectations for government stability should be honoured fairly and without bias.
The issue of good governance raised by Gen-Z and the current government is highly relevant, necessitating corruption control, accountability, and efficient public services. While policy steps taken regarding economic governance must be unbiased, fair and impartial actions should not face opposition. Currently, a tug-of-war between the government and the private sector appears to have trapped the market in prolonged sluggishness. Along with administrative, economic, and political reforms, policy measures related to good governance must remain free from bias and partiality to achieve the change the country requires.
Similarly, regarding financial instruments, the share of capital expenditure within public spending must increase. Achieving this requires improving the budgetary system and amending the Public Procurement Act, as currently proposed by the government. At present, 70% of capital expenditure falls under this Act, which remains cumbersome and time-consuming. Consequently, the Public Procurement Act should be amended to ensure that development works start promptly and are completed on schedule. Numerous studies indicate that increased government capital expenditure creates a multiplier effect, making the market more dynamic. Therefore, the government must implement comprehensive improvements in capital expenditure over time, as this is a vital component of good economic governance.
While the substantial credit currently invested in land and real estate should be diverted toward productive sectors, ambiguities in land policies and regulations create challenges for disbursing credit within established thresholds. Specifically, the lengthy duration of land classification, delays in amending the Land Act, and recurring controversies surrounding land ownership limits hinder real estate transactions and complicate loan provision. A primary issue is that banks and financial institutions rely on land as their main collateral security when disbursing loans. Thus, the lack of policy clarity regarding land, the primary form of collateral, disrupts the entire financial credit flow system.
Although some banks have disbursed loans for hydropower by using the projects themselves as collateral, the unexpected risks involved are difficult to manage, leading financial institutions to prefer land. Increasing credit flow through project-based collateral requires an effective insurance system to bear these unexpected risks. However, such a system is not yet well-developed in Nepal. Without this infrastructure, increasing investment through project collateral remains difficult, posing significant challenges to funding emerging and evolving sectors.
The investment of financial institutions should be enhanced in productive sectors, as should credit access for emerging entrepreneurs. Although Nepal has improved in terms of access to financial institutions, access to credit remains limited to a few. There is financial deepening but not financial widening. Notably, investments from financial institutions in home loans, real estate, hire purchase, and margin lending hover around 25%, with frequent swaps between categories to meet central bank thresholds. Many institutions prefer to pay fines for failing to meet priority sector targets rather than attracting clients within those sectors.
Effective coordination and supervision among all institutions related to the financial market are essential. Unexpected shocks in cooperatives, acting as shadow banking agencies, wreak havoc on the market and undermine the credibility of the entire financial system. Additionally, decisions to tighten or relax the money market must be based on economic realities, which is the foundation of prudent policy. Since financial stability is the lynchpin of the economy, proper financial market policy must maintain a prudent circular flow of resources. By capturing market cycle volatilities through proactive corrective measures, the country can bring necessary dynamism to the overall economy.
