Impact Of Liquidity Crunch On Economy


A liquidity constraint, which happens when banks and other financial institutions (BFIs) do not have enough money to conduct business, has been affecting Nepal's economy. Unfortunately, the considerable negative repercussions of this crisis have prevented the nation's hopes for a post-pandemic economic rebound from materialising. Due to the trade deficit and the non-convertibility of the Nepali rupee, the country has repeatedly experienced liquidity crises. 

Credit disbursement has been raised in an effort to speed up the process of economic recovery, although this hasn't had much of an impact on deposits. As a result, since the start of the fiscal year, the economy has been dealing with a liquidity crisis.

Demand for funds

The Nepal Rastra Bank has implemented policy changes to reduce liquidity strain, although the issue is still in existence. The main problem driving the liquidity crunch is the inability to satisfy the demand for funds by borrowers to carry out their business operations.

When the government implemented a nation-wide lockdown three years ago to contain COVID-19, it caused a dramatic slowdown in financial activities, resulting in a liquidity crisis in the country. While efforts were made to lower interest rates, loans were given out far too frequently without adequate consideration of their effects. 

Inflation in real estate and the Nepal Stock Exchange resulted from BFIs beginning to lend working capital to companies regardless of whether they could turn a profit. The persistent demand for loans, which banks were unable to disburse due to a lack of capital and balanced deposits to support them, worsened the situation.

According to a survey by the central bank, the lack of liquidity was caused by payments made to foreign organisations for importing goods and services that were not offset by profits from international trade due to the balance of payments, trade deficit, political unrest, and interest rate fluctuations. Over the past few years, Nepal's imports have been gradually rising, causing a disparity between imports and exports.

This has had a detrimental effect on the economy by raising prices, causing inflation, and lowering the gross domestic product (GDP). This fiscal crisis is the result of a number of factors, including a trade imbalance, a balance of payments deficit, political instability, and frequent changes in interest rates.

Due to a considerable sum received in remittances, which also raises people's spending power and boosts GDP, Nepal enjoys a favourable situation with regard to foreign exchange reserves. Despite the fact that more Nepali workers are being hired abroad, the flow of remittances has declined. The liquidity issue might be lessened via remittance, which would provide cash flow and mobility. The situation is getting worse, thus the NRB sold a net amount of US$1.22 billion worth of foreign exchange reserves to infuse liquidity worth Rs. 147.14 billion.

Foreign exchange reserves fell at this time, and it appeared that the Central Bank would not be able to stabilise the economy. Nepalese citizens continued to purchase crypto-currency, and the lack of a suitable plan has prevented the government from stopping these unlawful activities. Additionally, the nation had to spend a sizeable sum in foreign currency to import petroleum goods, whose costs had been steadily rising, particularly after the Ukraine war, which resulted in a sharp rise in market prices. Unfortunately, it was not possible to use the foreign cash reserves to buy other items needed to keep the economy running.

The monetary policy of the years 2021/22 extended loan repayment deadlines by an extra year, specifically to mid-January 2023 in sectors hard hit by Covid-19, such as restaurants, nightclubs, public transportation, educational institutions, and entertainment businesses, in order to lessen the worsening situation. However, the anticipated outcomes were not successfully attained. 

The Department of Immigration cut the minimum amount of foreign currency needed for Nepalese travellers to $500, but only if the foreign cash was acquired from commercial banks using income certificates would they provide immigration clearance. Another rule put in place by the government restricted the quantity of gold that visitors may bring into the nation and assessed customs duties, which might have caused deposits to expand slowly during the current fiscal year. 

Loanable money

The government must actively finance deposits in the banking system and the supply of loanable money in order to raise the level of saving in the economy. International labour organisations estimate that 2 million people in Nepal could experience a lack of liquidity as a result of losing their jobs or accepting meagre pay.

The government should slash high taxes on petroleum products, strictly impose bans on luxury and non-essential items until the nation's financial situation has improved, maintain sound policies, and use appropriate strategies to balance fiscal imbalances in order to address the root causes of Nepal's liquidity crisis. 

Working together with the private sector is also crucial. It is important to execute sound macroeconomic policies and encourage private sector development in exporting industries. In order to increase the flow of idle treasury funds into the economy, the government must increase its capacity for expenditure. In order to prevent inflation from rising in the absence of economic activity, the central bank should limit the flow of money into unproductive sectors. The pressure on the liquidity will be reduced by helping to fill the unmet demand for funds by redirecting funds to productive industries.

(The author served as government secretary)

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