11 Asar, Kathmandu – Due to persistently high liquidity in banks and financial institutions, the central bank has spent NPR 30 billion within a single fiscal year to manage it. When excessive liquidity accumulates in banks, the central bank intervenes to absorb it, for which it must pay interest to the banks. In the previous fiscal year, the central bank spent NPR 10 billion in interest for liquidity absorption, while this year’s expenditure has already tripled.
As billions are being spent on liquidity management, the central bank is exploring alternative solutions, according to an official from the central bank. Plans are underway not only to incur interest expenses but also to introduce new financial instruments to address the excess liquidity issue.
The official noted that even when the central bank holds foreign currency and issues Nepali rupees in the market, liquidity increases. As the liquidity problem becomes more complicated and loan demand declines, managing it through foreign currency payments has become necessary.
“Once the necessary legal provisions are in place, there is a plan to pay amounts received in foreign currency back in the same currency,” the official said. “This process is called sterilized intervention, and discussions are ongoing about whether to implement it.”
Explaining the annual NPR 30 billion spending on liquidity management, the official said, “If imports decline, we anticipate price increases for goods and services produced domestically, particularly non-tradable goods and services.”
He further explained that prices of services for items that are not traded between countries—such as restaurant meals and haircuts—would rise. As an example, while Coca-Cola prices in Switzerland and Norway are not significantly different from Nepal, prices for haircuts and dining out are higher in Nepal.
To boost demand for loans, the central bank has been relaxing its credit policies, but this has yet to show an impact, the official added. Increased loan demand would help ease liquidity management.
Although there has been an expectation of expansion in lending and the housing sector, growth in these areas has not met expectations, resulting in ongoing challenges.
“The monetary policy for the next fiscal year will address the goal of increasing transactions in housing and real estate,” the official said. “Even though the central bank has implemented policy relaxations, a capital investment-friendly environment must be fostered.”
Sluggish economic activity has not created conditions for increased demand across markets, which has also impacted lending by banks and financial institutions. Low loan demand combined with increased remittance inflows is complicating the liquidity situation.
The central bank manages liquidity and controls irregular fluctuations in interest rates by either absorbing or injecting funds into the system.
When the central bank injects liquidity, it earns interest income; when it absorbs liquidity, it incurs interest expenses. Short-term interest rates in the financial system are determined by liquidity conditions. Interest rates fall when liquidity is high and rise when it is tight, primarily based on interbank market rates among banks and financial institutions.
When liquidity is abundant, interbank rates decline; when liquidity tightens, interbank rates tend to increase. The central bank implements an interest rate corridor based on interbank rates, ensuring the rate does not fall below the corridor’s floor.
When interbank rates fall below the floor, the central bank absorbs liquidity through facilities such as permanent deposit and deposit collection to tighten liquidity, preventing further rate decline. Conversely, if interbank rates rise, the central bank injects funds via permanent liquidity facilities, which helps reduce interbank rates.
Liquidity is also managed using repo and reverse repo operations. Fluctuations in liquidity cause interest rate instability, which led the central bank to establish the interest rate corridor.
The floor of the interest rate corridor is the interest rate on permanent deposits, while the ceiling is the rate on permanent liquidity facilities, commonly known as the bank rate.
After injecting or absorbing liquidity, the central bank maintains short-term interest rates within this corridor. Thus, high liquidity leads to interest payments by the central bank, whereas low liquidity generates income.
Up until Asar 10 of the current fiscal year, the central bank has issued loans amounting to NPR 200 billion for long-term purposes. Additionally, deposits totaling NPR 344.4 billion have been collected multiple times during this period.
The central bank has repeatedly absorbed liquidity worth NPR 3,629.8 billion during the same timeframe. The maximum interest rate on the instruments used for absorption is 2.75 percent, corresponding to the corridor’s floor rate.
The official stated that daily bank liquidity available with the central bank during this fiscal year ranges from NPR 80 billion to NPR 100 billion. “Based on this, the interest payments by the central bank are expected to be around NPR 28 to 30 billion,” he said. Recently, an average of NPR 110 billion liquidity has been deposited daily at the central bank. As of Thursday, NPR 110.3 billion from banks and financial institutions remained in the central bank.
What is Sterilized Intervention?
When there are sharp increases or decreases in currency values, the central bank intervenes, which may impact money supply and potentially raise inflation risks. To balance the money supply while adjusting exchange rates, sterilized intervention is conducted.
If the domestic currency strengthens, the central bank prints domestic currency to buy foreign currency from the market, increasing the domestic money supply and potentially driving inflation. To counteract this increase, the central bank sells government securities to withdraw excess money from the market.
Currently, the central bank holds sufficient foreign exchange reserves, enabling it to manage liquidity by making payments in foreign currency. This is expected to limit the supply of the Nepali rupee.
While this approach carries risks of reducing foreign reserves and potentially affecting imports, the central bank strives to avoid impacts on domestic monetary conditions and inflation, the official explained.
