Tuesday, 7 February, 2023

Tackling Liquidity Crunch

Uttam Maharjan


Banks have been in the grip of a liquidity crunch for the last few months. The problem with liquidity or loanable funds has been seen in the banking sector for the last 10 years. Every year it comes and goes but no effective mechanism has been developed to avert the crisis yet. Some short-term measures are, however, taken but it has proved to be inadequate.

There are several factors that lead to a liquidity crisis in the market. Remittances have been declining in recent times owing to problems with destination countries on account of the COVID-19 pandemic. Remittances have sustained the economy of Nepal for years. Sluggish remittances have affected deposits in banks. However, remittances are expected to grow in the days to come as the number of people aspiring to go abroad for employment is increasing.

Low expenditure
The biggest factor that is responsible for the liquidity crisis seems to be low capital expenditure. Every year, a capital budget is earmarked for development and infrastructure-building projects. Various ministries are allotted budgets. They also commit themselves to spend the budget. But when it comes to implementation, the performance is dismal. Till the five months of this fiscal year, the capital expenditure stood at less than seven per cent. Considering the dismal performance on the capital budget front, the Finance Minister the other day urged all the ministries to spend their capital budget up to 30 per cent by the end of Poush.

Slow progress in development projects is a chronic problem in the country. Neither the government agency concerned nor the contractors are serious about completing development projects by the stipulated deadline. There is virtually no mechanism for holding the concerned responsible for the non-completion of development projects. Sometimes, contractors are brought to account but the practice has not been sustained. There is also a proclivity for making non-budgetary demands and additional disbursement demands without heeding financial rules and procedures. There is also political pressure for transferring budgets to so-called pork-barrel projects to please constituencies, including voter banks. Sometimes, contracts are awarded without properly conducting feasibility studies.

Further, using budgets for development projects for the sake of spending the budgets after six or seven months of a fiscal year, sometimes even in the last month, is a bad trend. When projects are implemented hastily, the quality of work is mostly compromised. So the trend of spending budgets haphazardly must come to an end. Procedures and directions for the implementation of development projects should be followed in earnest. Besides, fiscal discipline, good governance and the rule of law should be followed by both the government agencies concerned and contractors.

There is no doubt that increasing capital expenditure will release money in the market. The budgetary funds kept in state coffers should come out into the market through capital expenditure. The Finance Minister’s concern about low capital expenditure is praiseworthy. In fact, the Finance Ministry and Nepal Rastra Bank should monitor the market for the liquidity crisis looming large any time.

The trade scenario in the country is bleak. Imports are rising at a faster rate than exports are. As a result, there is a trade deficit. Rising imports means depletion of foreign reserves for the payment of import bills. Depletion of foreign reserves is also considered one of the contributory factors to the liquidity crisis. Nepal Rastra Bank has recently tightened the import of some luxurious goods, which is a welcome step.
Banks have institutional deposits such as pension funds and insurance deposits at around 40 per cent. These deposits are risky. When such deposits are withdrawn in large quantity, banks may face it hard to manage the deposit-loan portfolios. On the other hand, individual deposits are far safer. Banks should, therefore, pay attention to increasing individual deposits.

The COVID-19 pandemic has also contributed to the liquidity crisis. The tourism sector has been badly hit, making a dent in earnings from the sector. That Indian tourists are cancelling hotel bookings in Pokhara owing to the Omicron scare is a matter of grave concern. The tourism sector was about to recover when the Omicron variant played havoc with the sector. The liquidity crisis has directly impacted the business sector. The business sector has suffered a lot on account of the COVID-19 pandemic. Businessmen are now in trouble because they are unable to get loans from banks as there is a shortage of loanable funds.

It would be pertinent to note that Nepal Rastra Bank has taken some proactive measures aimed at averting the liquidity crisis. The central regulator has adopted numerous financial instruments to mitigate the liquidity crisis, such as the release of Rs. 2,500 billion through a permanent liquidity facility, Rs. 69 billion through overnight repo, Rs. 220 billion through repo and Rs. 27 billion through direct purchase. A refinancing facility of Rs. 92 billion has been approved. The loan-deposit ratio will be kept at 90 per cent till the end of this fiscal year. Banks can count 80 per cent of the deposits at the local level.

Reliable mechanism
Nepal is all set to become a developing country by 2026. The country has met all the relevant criteria. For this, it is imperative for the country to revamp the economy, for which infrastructure development is a must. Easing of the liquidity crisis will open up avenues for accelerated industrialisation. The country is self-reliant in electricity and cement now. The country should also attain autarky in other sectors. This will narrow down the gap between imports and exports to a great extent. The country is also becoming a middle-income country by 2030. Therefore, the national economy needs to be reinvigorated accordingly.

Considering that the liquidity crisis has become a perennial problem, a reliable mechanism needs to be developed to steer clear of it on a long-term basis. The Finance Ministry, Nepal Rastra Bank and other stakeholders, including banks themselves, need to work in tandem to this end without delay.

(Maharjan has been regularly writing on contemporary issues for this daily since 2000. uttam.maharjan1964@gmail.com)