Easing liquidity

The injection of over 5 billion rupees into the market by the central bank has contained the rising inter-bank borrowing rate, bringing hopes that it might also take the pressure off commercial bank lending rates. As inter-bank borrowing rose to a whopping 14.5 percent last week the central bank, on Sunday, issued its largest ever repo -- lending by the central bank against government bills owned by banks-- worth 10 billion rupees. The impact was immediate: inter-bank borrowing rates quickly shrank to 11 percent and there are indications they might decline further. This is the first time, during the last three months, that the inter-bank borrowing rate has declined. Earlier, the central bank´s injection of 15 billion rupees into the market had failed to stabilize interest rates.



But the interest rate stabilization has come at a cost. The release of more money into the economy will push up inflation, which has already touched double digit, and boost imports, further upsetting the Balance of Payments (BoP)—the national account of the net inflow of foreign currency. The BoP deficit widened by a record Rs 20.5 billion during the first four months of the current fiscal year. This was largely due to growing mismatch between our imports and exports. As the liquidity crunch eases in the market it will further boost imports. To have a liquidity crunch and a BoP problem in the economy at the same time is like, in medical terms, having tuberculosis and diabetes simultaneously. If you inject glucose into the body, it will worsen the diabetes but if you reduce its intake, it will aggravate tuberculosis. Yet the central bank has injected liquidity into the market hoping that the BoP imbalance is a short-term aberration that will correct itself over time. Hope the central bank is right.



If the current injection of liquidity has pulled down interest rates thereby reducing the cost of productive investment, it may have some positive effect on prices. But the supply side of the Nepali economy is very weak and even weaker is its impact on prices. So the immediate beneficiary from easing the liquidity crunch, assuming it will pull down lending rates, will be borrowers from banks. Housing and auto loan rates have risen by as much as 8 percentage points in the last few years, hurting lower-middle and middle-class consumers who have borrowed from the banks. The banks must revise the lending rates as there are strong indications the liquidity crunch is over, at least for now. On Sunday the banks borrowed only 5 billion rupees equivalent of repo though the actual offer was 10 billion rupees.

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