Engineering to a 7% Growth Curve
For decades, Nepal’s monetary policy has been shackled by structural constraints: a rigid currency peg, volatile remittance-driven liquidity, and persistent fiscal dominance. The era of incrementalism must end; Nepal Rastra Bank must pivot boldly toward a pro-growth, developmental mandate to hit the 7% growth target.
The Fiscal Year 2083/84 budget appropriates Rs. 2,124.34 billion, aiming for 7% GDP growth and capping inflation at 6%. In alignment, the Nepal Rastra Bank (NRB) traditionally follows the budget with a monetary policy precisely calibrated to support this national reform agenda. The disciplined execution of these programmes, anchored in good governance, institutional integrity, and inclusive prosperity, can transform Nepal into a well-governed, prosperous, and dignified nation within five years.
The Normative Foundations of Monetary Policy
Since its formal inception in mid-1966, the NRB’s normative approach has been fundamentally aligned to anchor the government’s annual fiscal policy – the national budget. The NRB Act of 2055 BS (1998 AD) established the legal bedrock for shaping sound, comprehensive monetary strategies, which paved the way for formal annual monetary policy frameworks starting in FY 2059/60 (2002/03). Over the ensuing decades, the NRB has continuously sharpened its policy instruments, adapting its operational directives and institutional structures to respond dynamically to global economic shifts, regional landscapes, domestic political economy dimensions, and evolving national development goals. Built on these foundations, Nepal’s monetary policy is systematically engineered to support and execute four core objectives:
a) Stimulating Economic Growth –> the NRB prioritises credit expansion and investment to revitalise economic activity, targeting credit growth rates and contributing to the overall economic growth targets set by the national budget, consistent with national development aspirations.
b) Maintaining Price and Financial Stability –> a critical focus remains on containing inflation within a target range while ensuring financial sector soundness through proactive management of non-performing loans and institutional risk oversight.
c) Managing Structural Constraints –> policy operates within the framework of the “Impossible Trinity,” balancing a fixed exchange rate pegged to the Indian Rupee with capital controls. This inherently limits monetary policy independence and requires careful calibration of domestic instruments.
d) Supporting Productive Sectors –> monetary policy seeks to channel credit toward priority economic areas, including agriculture, small and medium enterprises, and productive industries, thereby fostering inclusive and broad-based growth.
Over the years, Nepal’s monetary policy has evolved with multifaceted dimensions and shifting emphases, reflecting the country’s changing political economy, development needs, and growth trajectories. While these four objectives remain central, their relative priority and operational design have adapted in response to fiscal pressures, external shocks, inflationary trends, and the government’s broader socioeconomic agenda demonstrating the NRB’s pragmatic and context-sensitive approach to monetary governance in a developing economy.
The Chinese Paradigm: A Developmental Alternative
In recent years, the Chinese model of economic development backed by sound monetary policies has led policy direction dramatically and advanced economic development and growth. In this context, the NRB should reference Chinese monetary policy as a strategic heuristic rather than a mechanical template. In 2020, Governor Yi Gang of the People’s Bank of China (PBOC) stated that the central bank responded proactively and implemented vigorous macro policies to mitigate economic shocks. Under his leadership, China’s monetary policy acted swiftly and decisively, maintaining aggregate liquidity at reasonable and appropriate levels, thereby fostering a monetary and financial environment conducive to safeguarding market entities and stabilising employment.
Governor Yi emphasised that, guided by central leadership, prudent monetary policy has been coordinated with proactive fiscal policy to support the “six fronts” namely, employment, finance, foreign trade, foreign investment, domestic investment, and expectations and the “six areas” that are employment, basic livelihoods, market operations, food and energy security, industrial and supply chains, and grassroots government functioning. This integrated approach provided strong backing for pandemic control and economic recovery. Since early 2020, the PBOC deployed substantial measures, including reserve requirement ratio cuts, central bank lending, rediscounts, and innovative direct-support tools for the real economy, yielding significant results. As pandemic conditions improved, the PBOC added RMB 1 trillion in inclusive finance lending and rediscounts to boost credit for agriculture, micro and small businesses, and private enterprises, with average financing costs kept below 5.5%, quotas expected to benefit over two million entities.
The PBOC also advanced targeted poverty alleviation financing, contributing to building a moderately prosperous society. Outstanding loans to impoverished and formerly impoverished populations reached approximately RMB 750 billion, benefiting more than 20 million people nationwide. Such monetary policy ensures entrepreneurs face no financing constraints for growth, underpinning China’s remarkable economic development and sustained GDP of nearly USD 20 trillion contrasting sharply with India’s GDP, which remains below USD 4 trillion. China’s experience offers a compelling counterpoint to the orthodox Washington Consensus framework that has historically guided International Monetary Fund and World Bank policy prescriptions. Rather than adhering rigidly to inflation-targeting orthodoxy, the PBOC operates within a broader developmental mandate, explicitly using monetary and credit policies to support industrial policy objectives, state-directed investment, and strategic sectoral upgrading.
Aligning Monetary Policy with China’s Developmental Paradigm to Revitalise Nepal’s MSME Sector
When the NRB formulates its monetary policy, the developmental trajectory of China offers a particularly resonant and contemporary case study. China’s strategic use of monetary tools to catalyse private investment and bolster fiscal policy provides a compelling model for an economy like Nepal’s, which is at a similar stage of structural transformation. However, a critical examination reveals a divergence in governance outcomes: while China has successfully leveraged its central bank to expand private sector credit as a driver of growth, the NRB’s current institutional framework and policy execution have yet to yield a comparably satisfactory expansion in private investment; a crucial missing pillar for national development.
This gap is most acutely felt within the micro, small and medium enterprise (MSME) sector, which forms the backbone of the Nepali economy. A palpable frustration pervades this segment, as entrepreneurs consistently identify a lack of formal credit access as the primary impediment to starting new ventures or upgrading existing operations. Multiple primary surveys corroborate this challenge, indicating that banking finance has not adequately permeated the MSME landscape. Consequently, a significant portion of these enterprises particularly those operating in rural and semi-urban areas remain financially excluded and are forced to rely on informal lending networks. These alternative sources, often involving family, friends, or local moneylenders, carry prohibitively high interest rates and onerous terms, which stifle long-term growth and innovation. While mechanisms like rural financing windows and microfinance institutions exist, their capacity is structurally limited. They are often constrained by small loan sizes and are ill-equipped to meet the dynamic capital requirements of evolving enterprises, particularly in a changing economic environment where business models and production needs are becoming more sophisticated.
Furthermore, formal banks and financial institutions (BFIs) encounter significant functional barriers that impede the deepening and widening of rural financial outreach. These barriers are not merely logistical but structural, preventing BFIs from effectively promoting and financing enterprise-based production, processing, storage, and distribution networks. Compounding this financial bottleneck is the perennial issue of physical connectivity. In Nepal, critical infrastructure especially road networks are frequently rendered impassable due to geographical challenges and seasonal disruptions, which in turn elevates operational risk and transaction costs for financial institutions, discouraging lending in remote areas.
This current challenge, however, is not without historical precedent. The foundation for enterprise financing in Nepal was laid in the late 1950s with the establishment of the Nepal Industrial Development Corporation (NIDC). Originally evolving from the Industrial Development Centre set up in 1957, the NIDC was legally incorporated under the NIDC Act of 1959 and served as the country’s first dedicated institution for industrial financing. For a time, the NIDC provided vital technical, financial, and operational support to nascent industries, establishing a strong institutional foundation. This early momentum was further reinforced by the operational mandates of Nepal Bank Limited, Rastriya Banijya Bank, and the Agricultural Development Bank, which collectively expanded finance into agricultural production, processing, transportation, and market infrastructure. However, subsequent political-economic shifts prompted a pivot away from this industrial base, steering the economy toward deindustrialisation and a heavy reliance on services and trade. Consequently, the agriculture and forestry sectors, areas where Nepal possesses distinct comparative and specific advantages failed to realise their potential as robust drivers of the real economy, leaving a critical gap in productive capacity.
The Industrial Enterprise Act 2076: A Targeting Mechanism
Given these challenges, the forthcoming monetary policy must be robust and explicitly designed to correct the functional barriers within BFIs that currently hinder MSME lending. This strategic pivot must be grounded in Nepal’s own established policy framework. The Industrial Enterprise Act 2076 provides a clear and structured classification of industries, which can serve as the targeting mechanism for the next monetary policy cycle. The Act further categorises industries registered by nature, including production-oriented (126,379), energy (829), agri/forestry (214,171), tourism (61,580), mining (488), services (219,194), construction (11,097), and community/information technology (6,880). As of Fiscal Year 2081/82, a total of 634,696 industries are registered, with the service sector accounting for the highest number. This data highlights a significant opportunity: while services dominate, the agri-forestry sector, a sector with immense potential and a high number of registrants, remains critically underfinanced.
Nepal: A Case Study in Structural Constraint and Policy Adaptation
Nepal constitutes an exemplary case study of a developing nation navigating the intersecting pressures of structural financial constraints, unique geopolitical dependencies, and heavy reliance on external financial flows. The country’s monetary policy is formulated and executed annually by the NRB, which operates within a highly distinctive political-economic ecosystem.
- The Indian Currency Peg –> to maintain macroeconomic and exchange rate predictability, the Nepali Rupee (NPR) has been tightly pegged to the Indian Rupee (INR) at a fixed rate of 1.6 NPR to 1 INR. Given the open border and heavily integrated trade relationship with India, Nepal effectively imports its baseline monetary policy stance and inflation trajectory from the Reserve Bank of India (RBI). This implicit policy transfer severely circumscribes the NRB’s autonomy in responding to domestically originating inflationary or deflationary pressures.
- Remittance-Driven Liquidity Dynamics –> worker remittances constitute a massive economic pillar for Nepal, consistently hovering between 25% and 28% of gross domestic product. When migrant workers remit earnings, they inject substantial liquidity directly into Nepal’s banking system, causing money supply and credit availability to oscillate wildly based on external migration patterns and host-country economic conditions, rather than responding to endogenous domestic economic cycles. This externalisation of liquidity creation introduces profound volatility into financial intermediation.
- Contemporary Policy Challenges and NRB Strategies –> recent data from the NRB illuminate the delicate balancing act confronting the monetary authorities. While consumer price inflation has trended at a relatively manageable 4% to 4.5% in recent periods, private sector credit growth has historically lagged behind broad money expansion. In response, the NRB frequently adjusts macroprudential regulations including loan-to-value ratios, risk-weighting requirements, and sectoral exposure caps to redirect credit toward productive enterprises rather than speculative activities such as real estate or equity margin lending. In recent fiscal cycles, Nepal’s external sector has recorded healthy balance of payments surpluses, accumulating foreign exchange reserves through robust remittance inflows. This surplus has eased liquidity conditions, consequently pushing short-term and interbank interest rates significantly lower often dipping below 3% which presents a dual-edged opportunity: while cheaper credit can stimulate investment, it also risks fuelling asset price bubbles and currency depreciation pressures. Given that interest rates do not always clear the market efficiently, the NRB heavily enforces quantitative limits, notably the strict Credit-to-Deposit (CD) Ratio, and sets sector-wise lending targets to ensure priority allocation to strategic areas such as agriculture, hydropower, and tourism.
Toward a Developmental Monetary Policy
In this context, the forthcoming monetary policy must pivot away from short-term financial engineering toward a more developmental and institutionally robust framework. The NRB must rigidly safeguard its regulatory independence as a bulwark against systemic banking failures, resisting entrenched political pressures that routinely seek to artificially inflate credit for short-term electoral or parochial gains.
Concurrently, the fiscal authorities must aggressively pursue deep structural reforms curbing profligate administrative expenditures, accelerating the actual execution of infrastructure projects, and diversifying a productive base that remains precariously over-reliant on volatile import revenue and remittance inflows. This coordinated approach mirrors the strategic coherence observed in China’s developmental state model, where monetary and fiscal policies are deliberately synchronised to support long-term industrial upgrading rather than episodic crisis management.
By drawing strategic lessons from China’s developmental finance model, addressing the functional bottlenecks of BFIs, and leveraging the granular classifications of the Industrial Enterprise Act and support to achieve growth target, the NRB can devise a policy framework that not only improves credit access for MSMEs but also revitalises Nepal’s productive base rebalancing the economy from a reliance on services to a more resilient model driven by agriculture, manufacturing, and value-added production.
(Neupane is a former Chairman of the Nepal Stock Exchange (NEPSE). He is currently serving as Research Fellow at Baya Himalaya, a policy research institution in Nepal)
