Monetary Policy of Nepal

A Seminar Paper

By

Rihana Kasula

Bachelor of Business Administration

Second Semester

Macroeconomics for Business

Submitted to

Faculty of Management

Bhaktapur Multiple Campus

Tribhuvan University

August, 2023
 2

1. Introduction

1.1 Background

Monetary policy is regarded as one of the most important macroeconomic tool or policy
in Nepal. Monetary policy is defined as the policies that are undertaken by the monetary
authority, generally the Central Bank, to achieve specific economic activities through a
change in money supply and rate of interest. It plays a vital role in stabilizing prices,
promoting economic growth, and minimizing unemployment levels.

According to (Warin, 2005), “Monetary policy is the process of overseeing a nation’s

money supply to complete specific objectives such as restraining inflation, or achieving
full employment, which usually involve setting interest rates, margin requirements, cash
reserve ratio, reserve requirement, capitalization standards for banks and non-banking
institutions, and acting as the lender of last resort.”

According to (Johnson, 1962), “Monetary policy is a policy employing central bank’s

control the money supply as an instrument of achieving the objective of general
economic policy.” Johnson mentioned that the growth in a country’s money supply can
strongly affect the country’s balance of payment.

R.P. Kent mentioned that the management of the expansion and contraction of the
money in circulation for the explicit purpose of attaining a specific objective such as full
employment is monetary policy. Monetary policy is concerned with the changes in the
supply of money and credit which influences the economic activity in the economy
through the variables like money or credit supply, rate of interest, etc.

Nepal is a small landlocked country located in South Asia. Nepal’s economy is mainly
based on agriculture that accounts for around 32% of its GDP and employs over 60%of
its population. The other industries in Nepal include manufacturing, tourism, and
remittances from Nepalese workers who are working in abroad. The monetary policy of
Nepal is overseen by the Nepal Rastra Bank (NRB), which is the central bank of Nepal.
The primary objectives of Nepalese monetary policy are price stability and external
 3

sector stability. NRB was established in 1956 and is responsible for formulating and
implementing monetary policy in Nepal. At the time, both Nepalese and Indian currency
were in circulation. To remedy this, and to establish Nepalese currency as the only
currency for domestic transactions, Foreign Exchange Act 1962 was introduced. In 1966,
NRB began conducting monetary policy through interest rate regulation and reserve
control.

In 2002, Nepal Rastra Bank Act was introduced. NRB Act provided clear framework for
conducting monetary policy comprised of policy instruments, operating targets, nominal
anchors, intermediate targets, exchange rate, intermediate targets and policy objectives.
Similarly, a provision was made to formally announce monetary policy. NRB has been
announcing yearly monetary policy ever since. In the same way, monetary policy for
2023/24 has been announced along with policies related to regulatory, payment system,
and foreign exchange management and have been formulated considering the
international and national economic as well as financial situation and their outlook,
policy stances adopted by developed and neighboring economies, the review of the
monetary policy of 2022/23, the objectives and priorities set out in the government
budget for 2023/24 and suggestions received from stakeholders, scholars, and the general
public.

Monetary policy is a crucial mechanism used by central banks to manage the money
supply, interest rates, and economic condition. It involves adjusting interest rates,
managing the money supply through open market operations, and implementing
unconventional measures when necessary. The specific approach and tools employed
may vary across countries, depending on the central bank’s mandate and objectives.

Overall, Nepal’s economy and monetary policy are made by a complex set of factors,
including geography, political climate and economic structure. Thus, understanding these
factors is essential for analyzing Nepal’s monetary policy and its’ impact on the country’s
economy.

1.2 Statement of the Problem

 4

Monetary policy plays a huge role in balancing act between achieving economic stability
and addressing the always evolving changes faced by nation’s economy. Policymakers,
economists, and stakeholders can get important insights by understanding how monetary
policy decisions impact factors including inflation, interest rates, investment,
employment and general economic stability. So, researching about the monetary policy
aids in evaluating the efficiency of the policy actions, seeing the potential risks and trade-
offs and developing the best future plans of action to accomplish the desired results in an
economy. That being the case, this seminar paper tries to answer the following research
questions:

 What is the theoretical perspective of monetary policy?

 What is the practice of monetary policy in Nepal?

1.3 Objectives

The objectives of the seminar paper are as follows:

 To review the theoretical perspective of monetary policy.

 To review the practice of monetary policy in Nepal.

1.4 Methods

In order to fulfill the objectives of the seminar paper, the literature review approaches of
the study is used. To study regarding the theoretical as well as empirical perspective of
monetary policy practice in Nepal, the books, research articles and journals are reviewed
and analyzed in order to draw the conclusion of seminar paper.
 5

2. Description and Analysis

2.1 Theoretical Review

Monetary policy refers to the actions taken by a central bank to manage the money
supply and interest rates in an economy, with the aim of achieving certain
macroeconomic objectives. The primary objective of monetary policy in Nepal is to
maintain the price stability, which is achieved by targeting various factors. To understand
the concept and operation of monetary policy, it is important to be aware of the
theoretical components of monetary policy listed below:

2.1.1 Theoretical Views on Monetary Policy:

Various theories on monetary policy are as follows:

Keynesian view of monetary policy:

Keynesian theory doesn’t believe in the direct link between the supply of money and the
price level that emerges from the classical quantity theory of money. They reject the
notion that the economy is always at or near the natural level of real GDP so that Y in the
equation of exchange can be regarded as fixed. They also reject the proposition that the
velocity of circulation of money is constant and can cite evidence to support their case.

Keynesians do believe in an indirect link between the money supply and real GDP. They
believe that expansionary monetary policy increases the supply of loan able funds
available through the banking system causing interest rates to fall. With lower interest
rates, aggregate expenditures on investment and interest-sensitive consumption goods
usually increase, causing real GDP to rise. Hence, monetary policy can affect real GDP
indirectly.

Keynesians, however remain skeptical about the effectiveness of monetary policy. They
point out that expansionary monetary policy that increases the reserves of the banking
system need not lead to a multiple expansion of the monetary supply because the banks
 6

can simply refuse to lend out their excess reserves. Furthermore, the lower interest rates
that result from an expansionary monetary policy need not induce an increase in
aggregate investment and consumption expenditures because firms and households
demands for investment and consumption goods may not be sensitive to lower interest
rates. For these reasons, Keynesians tend to place less emphasis on the effectiveness of
monetary policy and more emphasis on fiscal policy, which they regard as having a more
direct effect on real GDP.

Monetarist view of monetary policy:

Since the 1950’s, a new view of monetary policy, called the monetarism, has emerged
that disputes the Keynesian view that monetary policy is relatively ineffective. Adherents
of monetarism, called monetarists, argue that demand for money is stable and is not very
sensitive to changes in the rate of interest. Hence, expansionary monetary policies only
serve to create a surplus of money that households will quickly spend, thereby increasing
aggregate demand.

Unlike classical economists, the monetarists acknowledge that the economy may not
always be running at the full employment level of real GDP. Thus, in the short-run
monetarists argue that the expansionary monetary policies may increase the level of real
GDP by increasing the aggregate demand. However, in the long-run when the economy is
operating at the full-employment level, monetarists argue that the classical quantity
theory remains a good approximation of the link between supply of money, the price
level, and the real GDP - that is, in the long-run, expansionary monetary policies only
lead to inflation and doesn’t affect level of real GDP.

Monetarists are particularly concerned with the potential for abuse of monetary policy
and destabilization of the price level. They often cite the contractionary monetary policies
of the Fed during Great Depression, policies that they blame for tremendous deflation of
that period. They believe that the Fed should conduct monetary policy so as to keep the
growth rate of money supply fixed at a rate that is equal to the real growth rate of
economy over time. Thus, the monetarists believe that monetary policy should serve to
accommodate increases in real GDP without causing either inflation or deflation.
 7

2.1.2 Types of Monetary Policy:

There are basically two types of monetary policy. They are described below as follows:

Contractionary Monetary Policy:

Contractionary monetary policy refers to the actions taken by a central bank to reduce the
money supply and cash inflationary pressures in an economy. It is typically implemented
by raising interest rates, tightening credit conditions, and reducing the availability of
money and credit. The contractionary monetary policy is also known as restrictive
monetary policy.

When an economy experiences inflationary pressures, such as rising prices and excessive
aggregate demand, central banks may employ contractionary monetary policy to stabilize
the economy and maintain price stability. By reducing the money supply and increasing
borrowing costs, the central bank aims to decrease spending and investment, thereby
slowing down economic activity. Thus, under this method, the central bank tries to
discourage the expansion of credit through raising bank rate, cash reserve ratio, selling
securities in open market and implementing other appropriate selective measures.

One notable real-world example of contractionary monetary policy occurred during

United States Federal Reserve’s response to the Great Recession of 2007-2009. As the
economy faced severe financial turmoil and the risk of deflation, the Federal Reserve
implemented contractionary monetary measures to stabilize the economy. It raised
interest rates, reduced money supply and engaged in open market operations to withdraw
liquidity from the financial system. These actions aimed to curb inflationary pressures
and restore stability in aftermath of recession.

Expansionary Monetary Policy:

Expansionary monetary policy refers to the actions taken by a central bank to stimulate
the economic growth and increase aggregate demand by expanding the money supply and
 8

reducing the borrowing costs. It is typically implemented by lowering interest rates,

easing credit conditions, and increasing the availability of money and credit.

When an economy faces sluggish growth, high unemployment, or recessionary pressures,

central banks may employ expansionary monetary policy to spur economic activity and
encourage the investment and consumption. By increasing the money supply and
lowering borrowing costs, the central bank aim to boost spending, promote business
expansion, and stimulate overall economic growth. Generally, such policy encourages
expanding the credit through reducing bank rate, CRR, purchasing securities in the open
market and implementing other appropriate measures which ultimately increase the
aggregate demand in an economy and promote economic expansion.

One notable real-world example of expansionary monetary policy is the response of

many central banks, including the Federal Reserve, during the global financial crisis of
2008-2009. As economies faced severe recessionary conditions and deflationary risks,
central banks implemented expansionary measures to boost economic activity. They
lowered interest rates to near-zero levels, engaged in large-scale asset purchases
(quantitative easing), and implemented other unconventional policies to provide liquidity
and stimulate lending.

2.1.3 Instruments of Monetary Policy:

The economic variables that Central Bank is empowered to change at its discretion with a
view to control and regulate the supply and demand for money and availability of credit
is called the instruments of monetary policy. Monetary policy guides the Central Bank’s
supply of money in order to achieve the objectives of price stability (or low inflation
rate), full employment, and growth in aggregate income. This is necessary because
money is a medium of exchange and changes in its demand relative to supply, necessitate
spending adjustments. To conduct monetary policy, some monetary variables which the
Central Bank controls are adjusted-a monetary aggregate, an interest rate or the exchange
rate-in order to affect the goals which it does not control. The instruments of monetary
policy used by the Central Bank depend on the level of development of the economy,
 9

especially its financial sector. The instruments/tools of monetary policy are of two types
which are explained below:

Quantitative Instruments:

Quantitative Instruments affect the level of aggregate demand through the supply of
money and availability of credit. They contain general measures of monetary control and
these instruments are related with regulation of lending capacity of financial institution
especially commercial banks. The main quantitative instruments or tools are further
explained below:

 Bank rate policy: The bank rate is the rate at which central bank lends money to
commercial banks and rediscounts the bills of exchange presented by the commercial
banks. At times of inflationary pressures within the economy, the central bank raises
the bank rate. Borrowing from the central bank then becomes costly. Commercial banks
borrow less from the central bank. There is a contraction of credit and prices are
checked from rising further. On the contrary, during deflationary pressure (depression),
the central bank lowers the bank rate. So, the commercial bank will lower their lending
rates. Businessmen are encouraged to borrow more. Investment is encouraged. Output,
employment, income, and demand starts rising.

 Open Market Operations: The open market operation is the sales and purchase of
government securities and treasury bills (bonds) from the central bank of the country.
When the prices are rising, the central bank sells securities. The reserves of commercial
banks are reduced and their lending power is contracted. On the other hand, when
deflationary pressure starts, the central bank buys securities. The reserves of
commercial banks are raised. They can lend more credit. As a result, there will be
increase in money circulation.

 Cash Reserve Ratio (CRR): Cash Reserve Ratio is the percentage of total deposits
which commercial banks are required to maintain in the form of cash reserve with
central bank. Commercial banks are required by law to keep a certain percentage of
their deposits with the central bank in form of cash reserves. It is based on these excess
 10

reserves that commercial banks can create credit. By using this instrument, central bank
can increase the money supply by decreasing the CRR and vice-versa.

Qualitative Instruments:

Qualitative Instruments help to control the money supply and financial stability. They are
also known as selective credit instruments. The main selective credit controls are
explained below as follows:

 Regulation of Consumer Credit: An important instrument of credit control is the

regulation of consumer credit. It aims at regulating the consumer installment credit or
hire purchase finance. Hire-purchase finance is the method of using a bank credit by the
consumers to buy expensive durable goods like motor, car, etc. A certain percentage of
the price of durable goods is paid by the consumers as the down cash payment and the
remaining portion of the price financed by the bank credit. If the central bank wants
that more of bank credit should be given to the consumer, it may reduce down payment
and increase maximum period of repayment. On the other hand, if the central bank
desires to reduce the availability of such credit, it raises the amount of down payments
and reduces the maximum period of repayment.

 Change in Lending Margins: As we know, commercial banks generally give loans to

their customers against some securities. However, they don’t give loans to the full
amount of value of the security, but to an amount that is less than its value. The
difference between the value of the security and the amount of the loan granted is
known as margin requirements. The bank keeps this margin to protect themselves
against any kind of fall in the value of securities. The central bank influences the
availability of bank credit by fixing the margin requirement.

 Credit Rationing: Rationing means limiting the investment amount, interest rate and
loan, etc. It aims at limiting the maximum or ceiling of total amount of bank loans and
advances, as well as, in certain cases, fixing the maximum limit of loans for specific
purposes. Rationing of credit may take two forms:-
 11

 The central bank may fix the maximum amount of loans and advances for every
commercial bank.
 The central bank may fix maximum ratio of the capital of a commercial bank to
its total assets.

 Moral Suasion: Moral suasion (suasion is the short form of persuasion) is the method
of persuasion, request, informal suggestion, and advice to the commercial banks by the
central bank. The central bank convenes the meeting of the heads of the commercial
banks and explains them the need for the adoption of a particular monetary policy and
appeals to them to follow this policy. For example, central bank relies upon its moral
influence on the commercial banks as the head and leader of financial institutions.

 Publicity: Publicity is another method of selective credit control of monetary policy.

The central bank expresses its views about the various monetary and banking policies.
It may put forward its views by using facts and figures through the media of publicity.
The central bank publishes the facts and figures of macroeconomic condition of nation
such as GDP, NPV, inflation rate, interest rate, BOP, etc. Central bank uses this method
both for influencing the credit policies of commercial banks as well as to influence the
public opinion in the country.

 Direct Action: Direct action refers to various directives issued by the central bank from
time to time to the commercial banks to regulate the lending and investment activities.
The central banks in all countries pursue direct action against all banks, but against
erring banks that don’t follow the policies of the central bank. These direct actions may
take the form of refusal of discounting facilities, refusal of loans, charging of penal rate
of interest, etc.
 12

2.2 Empirical Review

Yadav (2023) opined that monetary policy is designed to stabilize the economy through
the management of liquidity in the market. It is generally implemented by the central
bank of the country. In developed countries and economies, this implies moderation of
interest rates based on the given level of inflation, output and other macroeconomic
variables. Traditionally, central banks used quantity of money balance to manage the
economy. Central bank injects liquidity into the market in times of recession to promote
the economic activities and absorb necessary liquidity from the market whenever the
economy is overheating. In present times, central bank functions in a similar way, but
with more emphasis on interest rates than on monetary aggregates.

Romer (2004), “Monetary Policy and the Great Inflation in the United States: The
Federal Reserve and the Failure of Macroeconomic Policy” reviewed the history of the
Federal Reserve’s monetary policy during the period of the Great Inflation in the 1970’s.
He argues that the Federal Reserve was too slow to recognize the problem of inflation
and failed to take decisive action to address it, which contributed to the severity of
inflationary episode.

Also, the study investigated the channels through which monetary policy affects the
economy. Romer identified the interest rate channel and the credit channel as important
transmission mechanisms. The interest rate channel operates through changes in
borrowing costs, which influence investment and consumption decisions. The credit
channel, on the other hands, emphasizes the impact of monetary policy on the availability
of credit and financial intermediation.

Governor Mahaprasad Adhikari expressed positivity regarding the monetary policy,

noting improvements in Nepal's economic index and a positive external economic
scenario. He also announced plans to encourage mergers and acquisitions of microfinance
financial institutions. Additionally, the monetary policy promises foreign exchange
facilities to industries/businesses aimed at exporting services, including IT. It also plans
to remove the system of paying foreign currency loans in Nepali Rupees as the impact of
 13

Covid-19 lessens. Furthermore, it seeks to provide instruments such as swaps for

managing foreign exchange risks in external loans provided by banks and financial
institutions.

Thapa (2016) mentions the impact of monetary policy actions such as CRR, open market
operations and bank rate on bank lending. In the study, panel data of total commercial
banks during the period of 1998 to 2019 were collected and analyzed using descriptive
statistics, correlation and regression analysis. This analysis shows that open market
operations and CRR have negative impact but bank rate has positive impact on bank
lending. Therefore, the central bank of Nepal should rely mostly on open market
operations. Further, the study recommends the central bank should hold CRR constant as
a cushion for the borrowers from fluctuating lending rates by commercial banks.

Friedman (1968) opined to analyze the role of monetary policy in stabilizing the
economy. The study used statistical methods and econometric models to estimate the
impact of the monetary policy on key macroeconomic variables such as output, inflation,
and interest rates. The study found that monetary policy has a significant impact on the
economy through control of money supply and interest rates. Friedman argued that the
central bank should use monetary policy to stabilize prices and promote economic
growth, while avoiding excessive inflation or deflation.

2.3 Monetary Policy in context of Nepal

Nepal’s monetary policy has evolved significantly over the years, with several key
milestones and reforms that have shaped its current framework. Here is a brief history of
Nepal’s monetary policy: 1956 - Establishment of Nepal Rastra Bank (NRB). NRB was
established as the Central Bank of Nepal with the primary objective of maintaining price
stability and promoting economic development. Monetary policy in Nepal started with
the establishment of NRB in this year. 1960s-1970s - Pegged primary objective of
maintaining price stability and promoting economic development. 1980s - Financial
sector reforms: Nepal implemented significant reforms to its financial sector including
the liberalization of interest rates, introduction of new financial products and instruments,
 14

etc. In mid 1980s, NRB began approaching monetary policy through the use of indirect
methods and the reforms paved a way for introduction of formal monetary policy
framework in the early 2000s. 2000s - Inflation targeting framework. In 2002, NRB act
was introduced. NRB act provided a clear framework for conducting monetary policy
comprised of policy instruments, operating targets, nominal anchors, intermediate targets
and policy objectives. Similarly, a provision was made to formally announce monetary
policy. NRB has been announcing yearly monetary policy ever since. 2010s - Focus on
financial inclusion and stability. 2020s - In recent years, Nepal has placed greater
emphasis on promoting financial inclusion and stability, including introduction of
policies and programs to increase access to financial services, etc. The primary objectives
of Nepalese Monetary Policy are price stability and external sector stability. However,
due to the emergence of COVID-19, the focus of monetary policy changed from
tweaking the economy to pulling the economy of the recession. For instance, NRB raised
the mandatory credit deposit ration from 80% to 85% for Banks and Financial Institutions
(BFI’s) in monetary policy of 2020.

2.3.1 Monetary Policy for fiscal year 2080/81

The monetary policy for the current fiscal year 2080-81 (2023-2024) is published by the
Nepal Rastra Bank (NRB). The central bank through the policy has dropped the policy
rate, and kept intact the mandatory cash ratio and the statutory liquidity ratio of banks and
financial institutions. Similarly, the bank rate has remained unchanged, and the bidding
rate in deposit collection has been decreased.

In an attempt to keep the national economy buoyant and back the government’s budget,
the Nepal Rastra Bank has carefully introduced a new, more flexible policy, Monetary
Policy for 2080-2081(2023/24). This policy has been formulated with the major
objectives of maintaining price and balance of payments stability as specified in the
Nepal Rastra Bank Act, 2002. The Nepal Rastra Bank aims to maintain sufficient foreign
exchange reserves to cover seven months of goods and services imports. It also prioritizes
keeping inflation within 6.5% and channeling financial resources to the productive sector
to help achieve the budget statement's economic growth target of 6%. The monetary
policy projects an increase of 12.5% in comprehensive money supply and 11.5% in
 15

private sector loans from banks and financial institutions in 2080-81. This projection is a
significant jump from the previous year, when such loans only increased by 4%.The
policy announces the review of the mandatory permanent account number system for
borrowers using loans/facilities beyond certain limits. It also introduces a framework to
assist banks and financial institutions in managing and reviving borrowers who face
difficulties due to natural disasters or special circumstances. To enhance supervision of
large borrowers, the policy will issue separate guidelines, aiming to decrease the over-
centralization of credit by modifying single customer credit facilities.

The existing monetary policy framework has been timely improved to make effective
liquidity management and thereby limit the volatility in interest rates, reduce financial
intermediation costs, and strengthen the monetary policy transmission. Since 2022/23, a
monetary policy rule has been introduced in which the annual inflation target and the
import capacity of the foreign exchange reserves are taken as a basis for setting the policy
rate. According to this rule, the policy rate will be revised upward when there is pressure
on inflation and import capacity of foreign exchange reserves, and will be revised
downward when there is no pressure. With this rule, the process of setting the monetary
policy stance has now been both data and theory driven. This policy rule is believed to
make the setting of monetary policy stance more transparent and make the policy more
effective to maintain macroeconomic stability. 19. As per the provisions in the monetary
policy for 2022/23, a procedure for the lender of the last resort facility has been issued.
The existing provision of determining interest rates on lending has been revised in
2022/23, so that lending rates can be set on a monthly basis as per the cost of funds.

2.3.2 Major Highlights of Monetary Policy 2023-24/2080-81

The monetary policy (FY 2023-24) was announced by Nepal Rastra Bank (NRB) while
taking into consideration the macroeconomic environment at the time. It has targeted
economic recovery and has emphasized price and interest rate stability, credit demand
security, and external stability. The target inflation rate set by NRB for FY 2023/24 is
at 6.5%. The International Monetary Fund (IMF) which previously expressed concerns
regarding credit fluctuation in the financial sector has shown appraisal for the current
 16

policy. The tightening policy in FY 2022/23 has helped the economy recover post
COVID-19 pandemic and global conflict effects resulting in the current policy aiming to
maintain macroeconomic stability. Some of the major policies highlights are listed below:

Trend on Inflation

The annual average consumer price inflation is expected to remain slightly above the
targeted level. The average consumer price inflation for eleven months of 2022/23 is 7.77
percent, while such inflation was 6.18 percent in the same period of 2021/22. However,
the y-o-y consumer price inflation registered 6.83 percent in mid-June 2023, being
slightly below the average annual expected inflation.

Figure 1

Trend on Inflation
9.00%

8.64%
8.50% 8.50%
8.26%
8.08%
8.00%
7.88%
7.77%
Inflation rate

Monthly rate
7.50% 7.44%
7.38%
7.26%
7.00%

6.50%
2 22 2 2 2 3 3 3 3
02 20 02 02 02 02 02 02 02
,g 2 , ct,2 ,2 c,2 ,2 ,2 ,2 r ,2
p v
De
n b ar Ap
-Au d-Se
d-O -No d- d-Ja d-Fe -M -
id i i id i i i id id
m m m m m m m m m

Source: Nepal Economic Forum

The increase in the prices of cereals, dairy products, spices, household consumables,
imported goods, and fuel along with the depreciation of Nepalese Rupees against the US
Dollar has generated pressure on inflation. However, the inflationary pressure seems to
gradually ease in response to subdued domestic demand and the declining trend of
wholesale price in India. Thus, the inflation rate was lowered from 7% to 6.5%, aiming to
 17

reduce the cost of short-term loans and put pressure on banks to lower overall interest
rates.

Credit Creation:

As per data collected by NRB, lending in the country’s private sector increased
by 19.4% on average in the last two decades. NRB had initially set a private sector credit
growth limit at 11.5% a decrease from 12.6% from the previous fiscal year to mitigate
excessive credit expansion. Nepali private sector umbrella bodies had previously
expressed concerns regarding the policy and high interest rates, weak demand, unstable
cash flow, low production, increasing unemployment and low confidence in the private
sector. In response, NRB officials have released statements indicating flexibility in its
implementation of the policy, as banks are expected to increase private sector loans up
to 15%. While the private sector has been pushing to lower bank interest rates, the
government must be cautious as low rates could potentially spur excessive economic
growth. This could further widen inflation in the country where food prices have already
increased by 7.5% (y-o-y) and non-food prices by 8.7% (y-o-y).

Figure 2

Trend on Private Sector Credit and Growth

30%

25%

20%

15%

10%

5%

0%
2019-20 2020-21 2021-22 2022-23

Target Actual
 18

Source: Monetary Policy 2023/24, Nepal Rastra Bank

Interest Rate Policy:

The NRB uses interest rate policy to control the money supply and achieve its
macroeconomic objectives. For example, if NRB wants to reduce inflation, it may
increase the interest rate to reduce borrowing and spending, which in turn reduces
demand and helps control inflation. On the other hand, if NRB wants to stimulate
economic growth, it may decrease the interest rate to encourage borrowing and spending,
which in turn increases demand and helps stimulate economic activity.

Table 1

Structure of Interest Rate

Policy Rates 2023 Jan 2023 Apr 2023 June 2023 July
Fixed Repo Rate 7.00% 7.00% 7.00% 7.00%
Fixed Deposit Collection Rate 5.50% 5.505 5.50% 5.50%
Standing Liquidity Facility (SLF) 8.50% 8.50% 7.50% 7.50%
Rate
Bank Rate 8.50% 8.50% 7.50% 7.50%
Source: Monetary Policy 2023/24, Nepal Rastra Bank

NRB has kept the policy rate for banks the same at 7.5% as it is set to maintain financial
stability in the banking sector and provide liquidity to banks. The deposit collection rate
has been lowered to 4.5% from 5.5% which further reflects upon NRB’s aim to support
credit demand. This minimum cash deposit requirement for Banks and Financial
Institutes (BFIs) is set by NRB to establish public trust and provide protection to public
deposits. The Statuary Liquidity Ratio (SLR) remains unchanged and ensures security
during sudden withdrawals from banks. Moreover, NRB is also aiming to decentralize
services within the financial institutions.

Reserve Requirements
 19

The NRB also uses reserve requirements to influence the money supply. Reserve
requirements refer to the amount of funds that banks must hold in reserve against
deposits. By changing the reserve requirements, the NRB can influence the amount of
money that banks can lend and thus control the money supply.

Table 2

Cash Reserve Ratio (CRR)

Financial Institutions 2023 Jan 2023 Apr 2023 June 2023 July
Commercial Banks 4.00% 4.00% 4.00% 4.00%
Development Banks 4.00% 4.00% 4.00% 4.00%
Finance Company 4.00% 4.00% 4.00% 4.00%
Source: Monetary Policy 2023/24, Nepal Rastra Bank

NRB has set the Cash Reserve Ratio (CRR) at 4% which remains unchanged from the
previous year. This minimum cash deposit requirement for Banks and Financial Institutes
(BFIs) is set by NRB to establish public trust and provide protection to public deposits.

Open Market Operations:

NRB also uses open market operations to influence the money supply in the economy.
For example, if NRB wants to reduce money supply, it may sell government securities in
open market, which reduces the amount of money available to the banks for lending.
Conversely, if NRB wants to increase money supply, it may purchase government
securities in open market.

Table 3

Statement of Monetary Management

Particulars 2020/21 2021/22 2022/23

A. Liquidity Injection 438,277.1 9,702,410.0 5,518,186.2
1. Repo 50,000 270,000.0 316,500.0
2. Outright purchase - 55,915.9 89,700.0
 20

3. Repo Auction* 17,937.1 206,388.0 97,972.6

4. Standing Liquidity Facility 370,340.0 9,170,106.1 2,727,112.3
5. Overnight Liquidity Facility* - - 2,286,901.3
B. Liquidity Absorption 303,290.0 60,000.0 108,200.0
1. Reverse Repo 109,540.0 28,350.0 88,200.0
2. Outright Sale - - -
3. Deposit collection auction 193,750.0 31,650.0 20,000.0
4. Deposit collection auction* - - -
C. Net Liquidity 134,987.1 9,642,410.0 5,409,986.2
*Transaction under interest rate corridor

Source: Monetary Policy 2023/24, Nepal Rastra Bank

Foreign Exchange Reserve

Nepal foreign exchange (forex) reserves have become an important aspect of inflation
control since Nepal’s economy is heavily dependent on imports. Due to a large flow of
remittances and reduced imports of goods in the first half of FY 2022/23, the current
account deficit dropped from 12.8% to 12.03% by 0.5% of the total GDP. The lower
deficit has allowed accumulation of forex reserves, which increased from USD 9.5 billion
in mid-July 2022 to USD 10.1 billion in mid-June 2023. However, the lower imports
contributed to an economic downturn as it affected most of the import-dependent
business activities in the country. In the current policy, NRB is aiming to maintain forex
reserves to cover seven months of imports of goods and services. The current
reserves cover 9.4 months of imports which is higher than the policy floor. With the
strong flow of remittance and export of electricity, a moderate imports growth due to the
reserves, current account deficit is expected to narrow down to 2.8% of GDP. NRB has
also increased the foreign exchange limit for Nepali travelers going abroad to USD 2,500
from USD 1,500 due to sufficient forex reserves.
 21

2.4 NRB’s Monetary Policy Measures

The Nepal Rastra Bank (NRB), in its most recent monetary policy report, outlined the
following action that should be taken in 2023-24 to ensure the smooth operation of the
economy:

 Considering the domestic and external economic outlook, the policy rate has been
reduced by 50 basis points to 6.5 percent. Keeping the bank rate unchanged at 7.5
percent, the deposit collection rate has been reduced to 4.5 percent from 5.5 percent.
 Secondary open market operations and deposit collection auction will be opened if the
weighted average interbank rate, taken as an operating target, becomes higher than the
bank rate and lower than the deposit collection rate.
 The provision of providing a standing liquidity facility (SLF) at the bank rate and an
overnight liquidity facility (OLF) at the policy rate has been kept unchanged.
 A provision will be made to provide the standing deposit facility (SDF) at the lower
bound of the interest rate corridor in order to make IRC more effective.
 Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR) have been kept
unchanged.

3. Conclusion
This paper analyzes that as the macroeconomic indicators deteriorated in the past; it has
increased uncertainty regarding the prospect of a full economic recovery. The monetary
policy in Nepal is formulated and implemented by the Nepal Rastra Bank (NRB), which
is the central bank of Nepal. The primary objective of NRB is to maintain price stability
and promote economic growth. To achieve this objective, NRB uses various monetary
policy instruments, such as open market operations, reserve requirements, and the policy
interest rates. Monetary policy 2023-24/2080-81 was published by NRB much recently.
The implementation of this policy is expected to promote macroeconomic stability,
enhance the productive use of financial resources, expand financial access and help
achieve the goal of high and sustainable economic growth. Necessary revisions will be
made in policies related to the monetary, financial sector, payment system and foreign
 22

exchange management by doing quarterly reviews of the economic and financial

situation.

Nepal’s monetary policy has been formulated with the major objectives of maintaining
price and balance of payments stability as specified in the Nepal Rastra Bank Act, 2002.
The policy statement also includes the financial sector, foreign exchange management
and payment system-related policies that aim to enhance financial access maintain
financial stability and develop a secure, healthy and sound payment system. Despite
facing challenges such as limited economic data, political instability, and structural
constraints; Nepal’s monetary policy has been relatively achieving its objectives. The
NRB has been successful in maintaining the price stability and supporting economic
growth, over the past decade.

However, there are still areas for improvement in Nepal’s monetary policy. For example,
there is a need to strengthen the economic capacity for economic analysis and
forecasting, as well as to promote financial inclusion and access to credit in order to
strengthen the transmission of monetary policy through the banking system. Additionally,
there may be opportunities to strengthen regional cooperation and coordination on
monetary policy issues.

Overall, the monetary policy of Nepal plays a crucial role in maintaining macroeconomic
stability and supporting economic growth. However, there is still room for improvement
in the implementation of monetary policy. It will be important for NRB to continue and
refine its monetary policy framework and tools to meet these challenges and achieve the
objectives.
 23

References

Friedman, M. (2002). The role of monetary policy in money, interest, and prices.
Transaction Publishers.

Gelal, P. R., Dhungel, B. D., & Giri, K. (2022). Macroeconomic for Business.
Kathmandu: Kriti Publication Pvt. Ltd.

Johnson, H. G. (1962). Monetary Theory and Policy. American Economic Association.

Kan, D. (2022). Economic discussions. Retrieved from Keynesian and Monetarist views
on monetary policy:
https://www.economicsdiscussion.net/keynesian-economics/keynesian-and-monetarist-
views-on-monetary-policy/14753

Keynes, J. M. (1936). The General Theory of Employment, Money and Interest. New
York: Harcourt Brace Jovanovich.

Nepal Economic Forum. (2023). Key highlights of monetary policy of Nepal FY 2022/23 .

NepalRastraBank. (2023). Monetary policy archives. Retrieved from Monetary policy for
the fiscal year 2080/81: https://www.nrb.org.np/category/monetary-policy/

Romer. (2004). Monetary Policy and the Great Inflation in the United States: The Federal
Reserve and the Failure of Macroeconomic Policy. 84-1055.

Shaw, G. K. (1973). Monetary policy theory. Central monetary authority.

Thapa, B. (2016). An empirical analysis of monetary policy transmission mechanism in

Nepal. pp. 77-94.

Warin, T. (2005). Monetary Policy: From theory to practices. Vernont: Middlebury

College Working Paper Series .
24