Liquidity Problem : An Indicator of Weak Economy

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Liquidity Problem : An Indicator of Weak Economy

All it takes to address the current problems in liquidity are honest considerations in resolving the issues with proper planning and execution of economic policies.  


The crisis of lonable fund in the country’s banking system has become a major topic of discussion these days. However, most of the discourses in this regard are focused on finding short-term solutions to tackle the problem. What actually is the liquidity crisis and the reasons behind the worsening situation have not yet been discussed in depth. In the meantime, some banks have stepped up to borrow money from abroad as an immediate solution. This way, the ongoing discussions are not conclusive in themselves. 

Reasons Behind Liquidity Crunch
Liquidity and inflation are closely interrelated. It is believed that Nepal’s inflation is tied to the inflation in India. India which has seen its inflation rate rocket to eight percent has no controlled level of inflation. India has been able to tame the inflation to less than four percent by following the simple measures of financial discipline. But in Nepal, the monetary policy which was presented before the budget speech of the current fiscal year had projected that the inflation rate would hit seven percent.

Meanwhile, the average economic growth of the country in the last 4-5 years has been just four percent. If the remittance fueled economic activities are excluded, the economic growth will plunge to a mere three percent. Also, the size of the budget has doubled. This indicates either the budget is not real or the government bodies themselves have been spending a huge chunk of money from the budget in unproductive sectors.

The central bank must have understood that there is excess liquidity in the market to achieve the targeted economic growth. Nonetheless, the country’s economy has not been able to benefit from the excess liquidity. 

At present, 90 percent of income in the country is spent on consumption. The sharp increase in consumption rather than production has been a major factor behind the rising inflation level every year. Now, the government needs to seriously focus on increasing the capital expenditure. High level NRB officials accept this fact. And, the government also understands the fact very clearly.

Autonomy of NRB
When a general businessperson knows how his/her business is affected by the scarcity of liquidity, there is no question that the government and the authorities concerned aren’t aware of the situation. Nevertheless, there is a question why the central bank is not taking any proactive step to address the issue. The back seating of Nepal Rastra Bank (NRB) in this regard raises concerns about the autonomous status of the central bank.

The last few years have seen frequent changes in the government. The thrust of political parties to come to power and exert influence is the main reason behind the increase in unproductive sector spending. NRB understands that inflation will rise further if the cash flow rises in the market. This is why the central bank has been stating rise in inflation as a long-term problem for the country’s economy.

The discussions on availing foreign capital in the form of loans and investments to ease the problems in liquidity management have gained momentum recently. However, it is not clear if the international lenders and investors will lend or invest. They will only provide capital after analyzing various economic and business indices. The fear that foreign investors won’t invest here is the likely reason behind Nepal’s inability to go into the credit rating system. The interest rate difference cannot be the only basis for bringing foreign money. Foreign investors seek a guarantee that they can repatriate their investments after certain time. In the meantime, they can set various conditions to making investment.

Demand Analysis of Liquidity
Citing the shortage of liquidity, commercial banks have been lending money at 14-15 percent interest rate which they have taken at 12 percent as deposits. In this situation, how will long-term investments be sustainable? It is important to consider that investment goes only to stable market. Taking loans at a higher interest rate is only a short-term solution. If any industry has taken loans in the current fiscal, it is only because of its compulsion. The expansion of such compulsion increases risks of a systematic failure. At present, debtors might have borrowed money at higher interest rates to service earlier loans they have taken from financial institutions. It is likely that the money with high interest rates can flow to sectors including real estate and stock market where transactions are fast.

The increasing land prices across the country also prove this. The inside reasons behind the surging demand for capital have not been analysed.  Now, there is a need for all stakeholders to relatively analyse and engage in liquidity management. There should be different plans to direct the money supply to the productive sectors. Similarly, we also need plans to maintain the inflation rate at 4-5 percent and lending rate at 7-8 percent. The upcoming budget needs to address these issues.

Is Real Estate Sector Unproductive? 
The government considers real estate as an unproductive sector without making any plan to link its dimensions with other productive sectors. The real estate business is directly linked to productive sector industries including cement, steel and construction materials. These industries have created employment opportunities. The real estate sector looks unproductive because the government has failed to manage it.

For instance, let’s take an example of the telecom sector. The quality of telecom service has noticeably improved over the years because of the limited competition between the telecom companies. If there were too many service providers in the country, the telecom business would not have been sustainable. 

It is not good when the supply of any good or service exceeds the demand. This has already happened in the real estate sector. The real estate business has largely been Kathmandu-centric and has not been monitored properly.

If the government had worked to link this sector with other productive sectors, the scenario today would have been different. The real estate business holds a huge potential in cities like Birgunj, Biratnagar, Pokhara, Dhangadhi and Mahendranagar, among others.

Programme Implementation
Mega projects in Nepal take almost one to two decades to complete. The projects don’t get enough budget allocation. As a result, the construction of the projects gets delayed and the cost run also increases. There are problems in budget allocation. There are political recommendations to allocate budget for the projects with low feasibility. This affects budget allocation for productive sectors every year. So the national budget always needs to prioritise the productive sectors.

Corruption in Nepal is out of control. The money earned from corruption is spent on personal consumption. This money never goes to the productive sector. In the meantime, the savings of the general public have decreased. The limited savings is deposited in finance companies, cooperatives and microfinance companies. Large banks have been targeting wealthier people for deposits. The saving of the people is the capital of the country. So, the government should work to bring money to the banking channel.

Way Forward
The demand for money should be managed properly. For a sustainable economy, the government should make an investment-friendly environment in the country. The government should increase investments in sectors like manufacturing, tourism, and agriculture and infrastructure development. The investments by BFIs also should be monitored properly. Hiding the problems is not going to help. 

Agrawal is the president of the Nimbus Group.

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