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Interest rate corridor becomes dysfunctional

2018-10-04

The interest rate corridor (IRC) implemented by Nepal Rastra Bank (NRB) on short-term interest rate in a bid to stabilise the long-term interest rates on deposit and credit has become dysfunctional.

Introduced through the Monetary Policy in fiscal 2016-17, initially the band of the interest rate corridor was not fixed and the middle point of the upper and lower bands was taken as the repo rate. After fiscal 2017-18, NRB fixed the upper and lower bounds of the corridor and started making interventions through repo and reverse repo whenever the limits were breached.

The Monetary Policy of fiscal 2018-19 has given continuity to the fixed corridor mechanism and has raised the lower ceiling to 3.5 per cent from three per cent of the previous fiscal and brought down the upper ceiling of the interest rate corridor to 6.5 per cent from seven per cent of last fiscal.

The interest rate corridor is executed on short-term interest rate like interbank rate, repo rate, treasury bills and other short-term monetary instruments. The central bank introduced the interest rate corridor to keep the short-term interest rate stable so that long-term interest rate like deposit rate and credit rate could be stabilised.

The Monetary Policy 2018-19 has envisioned keeping the short-term interest rate in between 3.5 per cent and 6.5 per cent to stabilise interest rates. However, the central bank has not mopped up liquidity from the market despite the interbank rate plunging below 1.5 per cent. NRB should have intervened and mopped up excess liquidity to keep the interbank rate within the interest rate corridor.

Stating that the central bank is ‘aware of’ and ‘monitoring’ the market situation, Nara Bahadur Thapa, executive director of NRB, said, “We are allowing the rate to drop below the limit as we have to bring down the interest rate on credit.”

It is reported that Finance Minister Yubaraj Khatiwada, who had earlier served as the central bank governor, has instructed NRB not to enforce the interest rate corridor. “The finance minister does not see any rationale and effectiveness of the interest rate corridor that NRB has implemented,” a high-level source at the central bank told The Himalayan Times.

Earlier, NRB used to mop up liquidity if the interbank rate fell below the lower floor of the corridor and inject liquidity when the interbank rate rose close to the upper floor of the corridor. Thus, the interest rate corridor of NRB has helped stabilise short-term interest rate.

Despite NRB letting the interbank rate fall, it has not helped bring down the credit rate, according to bankers. Dysfunction of IRC will also plunge the government returns on securities to the BFIs and will ultimately affect the base rate of BFIs and lending rate will go up, they said.

Interbank borrowing cannot be used for the purpose of calculating credit to core capital cum deposit (CCD) ratio and for lending. It is taken for a short term to maintain cash reserve ratio, to maintain the statutory liquidity ratio provision. Banks and financial institutions have been obtaining fixed deposits at no less than 10.5 per cent and the rate of general savings is still high, which is why the credit rate will remain high in this fiscal too, as per bankers.

NRB has been putting pressure on banks to bring down the credit rates. However, BFIs are more aggressive in lending than deposit collection and the mismatch in deposit collection and credit expansion could dampen the aspiration of the government and regulator to bring down the lending rates.

The central bank’s macroeconomic report of the first month of this fiscal showed that credit expansion by BFIs increased by 0.7 per cent in the review period compared to a growth of 0.4 per cent in the corresponding period of the previous year. However, deposit collection decreased by 0.4 per cent in the review period compared to a growth of 1.3 per cent in the corresponding period of the previous year.

Source: The Himalayan Times