Row Over Interest Rate

There is a metaphor 'invisible hand' which describes how the free-market economy works through the acting of unseen market forces. It is said, in the free-market environment, that the economy is operated by invisible hands. Here, the invisible hands refer not to the hands of some supernatural or divine power but the two market forces of demand and supply which constitute the price mechanism.  In such economy, the market demand and supply are influenced by self-interest of respective economic agents. Therefore, in laissez faire economy, interactions between the demand and supply have to play the key role in determining prices in all types of market including product market, factor market and the financial market. In Nepal, after the incorporation of liberal economic policy, the market has been allowed to determine the price in both product and financial markets. 

Recently, the business community has called the government and the central bank to intervene in the current interest rate (price of capital) determining mechanism in order to make the capital cheaper. Saying that industries and trade of the country are on the verge of collapse mostly due to the high rate of interest, the business community has started to exert pressure on the government to take initiative to reduce interest rates. In this context, officials of the Nepal Rastra Bank (NRB) have said that it is not going to apply any rigid measures to reduce the interest rates ignoring the demand and supply scenario of the loanable funds in the market. According to a news report published in this daily on Wednesday, the NRB has said that the bank interest rates are not controlled by the central bank but are determined by the market interaction. 

At a programme organised to make public the macroeconomic and financial situation of the country, Governor of the NRB Maha Prasad Adhikari said the central bank, which has left the interest rate at the discretion of the market forces for more than three decades, would not interfere in it now. He added that the interest rate is insignificantly responsible for the current situation of the business sector as it has very small share in the cost of production of goods or services. Another NRB official Dr. Prakash Kumar Shrestha, said that the interest rate should be determined by the market on the basis of monetary demand and supply of the loanable fund and that the NRB doesn't have much role in it. According to him, interest has a cycle, and now it is catching a downward trend. 

Though there is no perfection in the working of free-market economy through the price mechanism, its fundamentals should not be ignored while applying measures to affect the interest rate. As the supply of loanable fund is still insufficient in the market, any measures to reduce interest rate may again lessen its supply. Therefore, measures to minimise interest rates without demand and supply management would not produce any positive result in the economy.  Instead, the central bank and the government have to make efforts to attract savings of the people into the formal sector from semi-formal (cooperatives) and informal sector. In addition to this, the central bank should be vigilant to ensure proper utilisation of bank credits, cartelling practices of banks and financial institutions to set high interest rate and efficiency enhancement in the entire financial sector.