Liquidity crisis is a common occurrence in Nepal due to the Nepalese rupee(NPR) being a non-convertible currency and a heavy trade deficit. The current liquidity crisis has emerged due to increased credit disbursements to encourage and foster economic recovery in the country.
Simply liquidity crisis is the result of BFIS’ (Bank and Financial Institutions) excessive lending of loans at lower interest rate to help the economy recover from covid-19. In fact, a liquidity crisis occurs when a company do no longer finance its current liabilities from its available cash. For example: it is no longer able to pay its bills on time and therefore default on payments. In order to avoid insolvency, it must be able to obtain cash as quickly as possible in such a case. It basically refers to a time when cash resources are in short supply and demand is high. During crisis business and consumers are charged high interest rates on loans which are more difficult to obtain.
The major types of liquidity can be :
1. Market Liquidity
2. Accounting Liquidity
Current, quick and cash ratios are most commonly used to measure liquidity.The different types of source of liquidity can be:
Short Term funds
Cash Flow Management
Negotiating its debt
Bankruptcy protection and reorganization
Free cash flow generation, margin and overall business trends
Likewise five liquidity ratios can be categorized as :
Quick ratio or Acid test ratio
Cash ratio or Absolute liquidity ratio
Networking capital ratio
The current liquidity crisis has emerged in the wake of increased credit disbursements to encourage economic activity in the country and foster economic recovery. BFIs have run out of loanable funds and the decision to raise internal loans by the government for development activities. BFIS is expected during the festival season from mid October to mid December. The period between mid-july and mid- january is generally associated with a lack of liquidity in the market, as direct and indirect taxation on individuals and corporation is due to the government during this period. Apart from expected minimal liquidity crunch in the market a number of factory are contributing to the current liquidity crisis.
The factors contributing to liquidity crisis:
1. Increased credit: To revise the economy after a prolonged lockdown enacted to contain the new monetary policy for the fiscal year 2022/23 increased the credit deposit (CD) ratio to be maintained by BFIS to 90% from a credit to core capital plus deposit (CCD) ratio of 85%. This led to BFIS lending to both individuals and corporations. The monetary policy also mandated BFIS to limit their CD ratio to 90% from a credit to core capita plus deposit (CCD) ratio of 85%. This led to BFIS lending to both individuals and corporations. The monetary policy also mandated BFIS to limit their CD ratio as per directives mandated BFIS to limit their CD ratio to 90% as of Dec 31, 2022 stands at 90.76%
2. Low Deposit: The monetary policy for the fiscal year 2022/2023 extended loan repayment and interest payment deadlines by one year to mid-january 2023 for sectors that are hard but by covid-19 such as restaurants, party places, public transport and entertainment companies, sustainable macro-economic policies along with foster in private sector growth in exporting industries are necessary to prevent another liquidity crunch in the market.
3. Declining Foreign reserves: According to NRB’S report, the foreign reserves of Nepal Rastra Bank have declined by 17% in November 2021 compared to November 2022. There is a decline of 11% in foreign reserves of Nepal Rastra Bank in the first four months of fiscal year 2021/22.
4. Mitigating actions adopted by the government: To ease the liquidity crisis , Governer Maha Prasad Adhikari announced that the Nepal Rastra Bank has floated NPR 2500 billion through permanent liquidity facility NPR 220 billion through repurchase agreement (repo), NPR 69 billion through overnight repo and NPR 27 billion through direct purchase.Interest Rate 31. In mid-July 2021, the weighted average interest rate of 91-day treasury bills was 4.55 percent, which reached 10.66 percent in mid-July 2022. 32. The average base rate of commercial banks was 6.66 percent in mid-June 2021, which reached 9.39 percent in mid-June 2022. In mid-June 2021, the weighted average interest rate of deposits was 4.72 percent, which reached 7.34 percent in mid-June 2022. Similarly, in mid-June 2021, the weighted average lending rate was 8.46 percent, which reached 11.54 percent in mid-June 2022
5. Remittance: It is another integral external sector that helps in acquiring foreign exchange money, increases that purchasing power of individuals, and has its fair share of contribution towards the growth of nations GDP. The steady drops in remittance and policies. The economic being highly dependent on remittance has negatively affected the liquidity.
Nepal Rastra Bank also required importers to deposit 100% cash in banks to open letter of credit for imports of luxury goods even though import loans only made up 5% of the total outstanding loans as of November 2022.
A possible reason for this could be that a working capital loan which makes up 20% of total outstanding credit could be used by importing business to open letter of credit which further increase import.
The department of immigration has reduced the minimum required foreign currency for Nepalese travelling abroad to USD 500 (NPR 59.5 thousand) from USD 1000 (NPR 118 thousand ). The department has also stated that immigration clearance will only be granted if foreign currency has been purchased from commercial banks after providing proof of income.
The government has also stopped issuing licence to importers of betel nuts, peas, pepper corn, and dried dates and plans to impose a quota on the import of such goods.
The steps taken by the government will slow down the declining foreign exchange reserves and add some liquidity into the market, a systematic change in required in Nepal to avoid the liquidity crunch of every few years. The major root cause Nepal’s liquidity crunch which needs to be addressed. Sustainable macro- economic policies along with fostering private sector growth in exporting industries are necessary to prevent another liquidity crunch in market.The economy as the funds from the remittance would allow mobilizing of cash inflows case the liquidity situation.The growth of broad money in mid-June 2022 stood at 9 percent on a year basis compared to the projection of 18 percent for 2021/22.
The growth rate of credit to the private sector from the monetary sector stood at 16 percent in mid-June 2022 on a y-o-y basis compared to the projection of 19 percent for 2021/22. 38. The existing operating target of the monetary policy is to maintain the inter bank rate of the BFIs within the corridor of 4.0 percent to 7.0 percent. The interbank rate stood at 7 percent in mid-June to mid-July 2022. 39. In 2021/22, the bank availed the liquidity of Rs.9702.41 billion (based on a transaction basis). Under this, Rs.476.39 billion was availed through a repo, Rs.55.92 billion through ouright purchase, and Rs.9170.11 billion through the standing liquidity facility. The current account has been in deficit since 2017/18. In 2021/22, the current account deficit, by increasing further, is expected to reach 13 percent of GDP. The current account has been in deficit for a long time and its size is increasing over the period, which has created a challenge not only in external sector stability but also in maintaining overall economic stability and achieving sustainable and high economic growth. Although the number of workers going abroad and tourist arrival has improved, the pressure on the current account and BoP is expected to continue for some time.The government has made it mandatory for traders to maintain a 100 percent margin when opening a letter of credit to import certain products in order to reduce the import of minor non-essential items. The government should maintain policy measures to help resolve fiscal imbalances, increase spending efficiency, stimulate private sector development, and bring the impact of the epidemic and liquidity crisis on the financial sector into sharper focus to help limit adverse risks.
The current account and balance of payments deficit have increased significantly due to the rapid expansion of aggregate demand relative to domestic production. As a result, there has been pressure on the banking system liquidity and interest rates. The pressure on prices and the external sector is likely to continue for some time given the international economic outlook, the Russia-Ukraine war, increase in fuel prices, the situation of domestic production and aggregate demand, and the trend of import and remittance flows.. Hence, the stance of monetary policy has been cautiously tightened considering the price and external sector outlook, and the target of economic growth and development to overcome liquidity crisis.