Key Takeaways
- Beyond the policy rate, Nepal’s credit paralysis stems from a deeper crisis of confidence and flawed, collateral-dependent risk models within banks, which monetary easing alone cannot fix.
- The Indian peg’s price, while providing essential currency stability, effectively outsources a portion of Nepal’s inflation control, forcing the Nepal Rastra Bank (NRB) to react to Delhi’s policy moves rather than purely domestic needs.
- Real estate’s zombie assets, overvalued on bank ledgers and locking up trillions of rupees in unproductive land, are the true bottleneck. Without a mechanism for write-downs or restructuring, cheap credit will simply inflate new bubbles rather than fund productive enterprise.
Introduction
In the quiet corridors of Baluwatar, the Nepal Rastra Bank (NRB) is engaged in an act of economic vertigo. Picture a tightrope walker, balanced precariously over a canyon. On one side lies the abyss of runaway inflation, eroding purchasing power and destabilizing the lives of ordinary Nepalis. On the other, the chasm of economic stagnation, where businesses shutter, jobs vanish, and a generation’s ambition withers. This is not mere metaphor; it is the daily operational reality for our central bank. The policy rate is its balancing pole, and every fractional adjustment carries immense weight.
The pressures are immense and contradictory. The private sector, from large industrial houses to small traders, is desperate. After a period of aggressive monetary tightening to curb post-pandemic excesses and protect dwindling foreign reserves, credit growth has stalled. Businesses, laden with debt taken at previously lower rates, are struggling to service their loans, let alone invest in expansion. Their calls for the NRB to slash interest rates and inject liquidity into the system are not just loud; they are existential. Yet, the NRB is also mandated to be the guardian of price stability. With consumer inflation persistently hovering near its tolerance ceiling, a premature and aggressive loosening of monetary policy could undo all the painful work of the past two years, un-anchoring inflationary expectations and triggering a new cycle of instability.
This article argues that the debate over interest rates, while dominant, is a deceptive simplification of a far more complex structural malaise. The core tension is no longer a straightforward trade-off between inflation and growth that can be managed by the NRB’s traditional toolkit. We are at a juncture where the very plumbing of our financial system is clogged. This analysis will deconstruct the specific pressures on the NRB, explore why cheaper credit may fail to flow to productive sectors, and conclude with a strategic outlook: without courageous and deep structural reforms, particularly in the real estate and manufacturing sectors, monetary policy will prove to be a blunt and ultimately ineffective instrument. The tightrope walker cannot defy gravity forever.
The Anatomy of Stagflationary Pressure
To comprehend the NRB’s dilemma, one must first dissect the two opposing forces that are crushing the Nepali economy: persistent inflation and anemic growth. This is the textbook definition of stagflation, a particularly vicious economic condition that makes standard policy responses ineffective, akin to trying to solve a puzzle with the wrong pieces. The uniqueness of Nepal’s situation lies in the specific origins of these pressures.
Nepal’s inflation is not primarily a story of a booming economy with too much money chasing too few goods, a classic ‘demand-pull’ scenario. Instead, it is a stubborn beast fed by external shocks and domestic inefficiencies—a ‘cost-push’ phenomenon. The most significant factor is our pegged exchange rate with the Indian Rupee. While this peg provides a crucial anchor of currency stability and facilitates trade, it also means we effectively import India’s inflation. When food, fuel, or manufactured goods prices rise in India, they are transmitted almost directly into our domestic market. Consequently, the NRB’s ability to run an independent monetary policy is circumscribed. It cannot, for long, maintain significantly lower interest rates than the Reserve Bank of India (RBI) without risking capital flight and pressure on our foreign reserves. Thus, when the RBI raises rates to combat its own inflation, the NRB is often forced to follow suit, regardless of domestic growth conditions.
Compounding this are our home-grown supply-side rigidities. The journey of a tomato from a farm in Dhading to a kitchen in Kathmandu is a masterclass in value addition through inefficiency. Multiple layers of intermediaries, transport syndicates, and inadequate cold storage facilities ensure that by the time produce reaches the consumer, its price bears little resemblance to the farm-gate price. This is not a problem that can be solved by adjusting the policy rate. Similarly, in sectors like construction, cartels in raw materials like cement and steel keep input costs artificially high. The NRB’s monetary tools are designed to manage aggregate demand, not to dismantle cartels or build highways. Using interest rates to fight this type of inflation is like using a fire hose to perform surgery—a powerful tool applied to the wrong problem, with damaging side effects on the rest of the economic body.
On the other side of the tightrope is the pressing need for growth, which in our bank-centric economy translates directly to private sector credit. The recent history here is crucial. The post-COVID period of 2020-21 saw an unprecedented credit expansion, fueled by regulatory forbearance and ultra-low interest rates. The NRB’s directive to banks to flood the market with cheap loans led to a credit-to-GDP ratio that ballooned to over 90%, one of the highest in the region. However, this capital was not channeled into building long-term productive capacity. Instead, it fueled a speculative frenzy in the stock market (NEPSE) and, most significantly, in real estate. The hangover from this party is severe. Businesses and households are now overleveraged. Banks, which once lent with abandon, are now staring at a concerning rise in Non-Performing Loans (NPLs). Their risk appetite has evaporated, replaced by a prudent, almost fearful, focus on balance sheet consolidation. This is the critical distinction: the problem is not merely a liquidity crunch (a lack of loanable funds) but a crisis of credit confidence (an unwillingness to lend and borrow). This is the stagflationary trap in its purest form: the central bank is being pushed to lower the price of money that neither banks are willing to lend nor businesses are in a position to borrow for productive investment.
Credit’s Crisis of Confidence: Why Cheaper Money Isn’t Flowing
The clamor from the business community for rate cuts assumes a simple mechanical relationship: lower interest rates equal more borrowing, which equals more investment and growth. This assumption dangerously overlooks the deep-seated crisis of confidence that now defines the relationship between Nepal’s lenders and borrowers. The transmission mechanism of monetary policy is broken, and simply lowering the policy rate will be like pushing on a string. To understand why, we must analyze the motivations of both sides of the credit equation—the bank and the borrower.
From the bank’s perspective, the primary concern is not the policy rate set by the NRB, but the alarming rise in Non-Performing Loans (NPLs). An NPL is a loan where the borrower has failed to make scheduled payments for a specified period (typically 90 days). When a loan becomes an NPL, the bank must set aside a portion of its own capital as a provision against the potential loss, directly hitting its profitability. In the aftermath of the recent credit boom, NPLs have surged, particularly concentrated in overdrafts, small-and-medium enterprise loans, and, critically, real estate and housing loans. Bank boards and management teams are now under intense pressure from shareholders and the regulator to clean up their balance sheets. Their incentive has shifted dramatically from aggressive growth to risk mitigation. In this environment, a bank’s loan officer is far more likely to be reprimanded for underwriting a new loan that goes bad than to be rewarded for expanding the loan book. This institutional risk aversion means that even if the NRB makes funds cheaper for banks, they will not necessarily pass on those lower rates or, more importantly, approve loans to any but the most blue-chip, low-risk clients.
Furthermore, Nepal’s entire lending architecture is built on a foundation of collateral, with land and real estate being the overwhelmingly preferred form. The current stagnation in the property market has created a “collateral trap.” The value of the primary asset backing a majority of the banking sector’s loan portfolio is now uncertain and illiquid. A business that could easily secure a loan of NPR 20 million against a piece of land valued at NPR 50 million two years ago now finds its borrowing capacity severely curtailed because the market value of that same land is unknown or has potentially decreased. Banks are reluctant to lend against an asset whose value they cannot confidently assess. This paralysis in the collateral market is a far greater impediment to new credit creation than an interest rate that is one or two percentage points too high.
From the borrower’s perspective, the desire for new credit is equally muted, despite the public outcry. For a vast swath of the business community, the primary concern is not new investment but survival. Many firms that took on significant debt during the 2020-21 boom are now caught in a debt overhang. Their cash flows are consumed by servicing existing high-cost loans, leaving little room or appetite for fresh borrowing. Their focus is on deleveraging—paying down debt—not on taking on more. For these businesses, a lower interest rate is a lifeline for survival, not a catalyst for expansion. Moreover, for a business to invest, it needs to see a clear path to returns, which hinges on consumer demand. With high unemployment, stagnant real wages (wages adjusted for inflation), and a pervasive sense of economic pessimism, aggregate consumer demand remains weak. A factory owner will not take out a loan to add a new production line, no matter how cheap the loan, if they see no one to buy their additional products. This demand-side weakness, coupled with chronic policy uncertainty and regulatory hurdles, creates a powerful disincentive for the long-term, fixed-asset investment that Nepal so desperately needs.
The Structural Sclerosis: Real Estate and Manufacturing at the Epicenter
The impotence of monetary policy becomes starkly clear when we move from macroeconomic aggregates to the two sectors that lie at the heart of our current predicament: real estate and manufacturing. These sectors are not merely suffering from a cyclical downturn; they are exhibiting symptoms of a deep, structural sclerosis, a hardening of the economic arteries that prevents the flow of capital to productive ends. The solutions they require are far beyond the mandate of the central bank.
Real estate has been the protagonist of Nepal’s recent economic story, but it has been a tragedy. For over a decade, the sector ceased to be about providing shelter and became the country’s primary speculative casino. Fueled by easy bank credit and a torrent of remittance income seeking tangible assets, land prices in urban and semi-urban areas detached completely from their underlying productive value. This had a dual, corrosive effect. First, it diverted a colossal amount of national capital—by some estimates, over 60% of total bank credit was directly or indirectly tied to real estate—into an inherently unproductive asset. Unlike investment in a factory, which generates employment, produces goods, and pays taxes, capital “invested” in a plot of land held for speculative purposes generates nothing until it is sold. Second, it made genuine entrepreneurship prohibitively expensive, as the cost of land became the single biggest barrier to starting a new factory, school, or hospital.
Today, this bubble has not so much burst as it has deflated into a stagnant morass. The market is frozen. Trillions of rupees of bank capital are now locked in these “zombie assets”—overvalued land parcels and half-finished commercial and residential projects that are not generating income. Banks are caught in a perilous “extend and pretend” game. They are reluctant to foreclose on these non-performing assets because doing so would force them to recognize massive losses on their books, as the real market price is far below the value at which the loan was issued. This could trigger a cascade of bank failures and a full-blown systemic crisis. This paralysis is the single greatest clog in our financial plumbing. It keeps bank capital hostage, preventing it from being recycled into new, productive ventures. Simply lowering interest rates will not solve this. In fact, it could make it worse by allowing banks to continue carrying these zombie assets on their books, hoping for an eventual market rebound, while starving the rest of the economy of capital.
While real estate was gorging on credit, the manufacturing sector was starved of oxygen. The decline of Nepali manufacturing is a long-term story, but the recent credit environment has accelerated it. A manufacturer competing with cheap imports from India and China faces a fundamentally different risk-return profile than a land speculator. Manufacturing involves complex operational risks, labor management, supply chain logistics, and long investment horizons. For a bank, a loan to a real estate developer, backed by a tangible (if inflated) piece of land, has always seemed simpler and safer than a loan to a factory. The cost of capital is just one factor in a manufacturer’s viability. Far more debilitating are the structural impediments: the exorbitant cost of electricity, which is often unreliable; a rigid labor law that makes it difficult to scale operations up or down; the logistical nightmare and high cost of transportation on poor infrastructure; and a byzantine bureaucracy for everything from land acquisition to environmental clearances. A small reduction in interest rates is trivial compared to these crushing operational costs. As a stark contrast, Bangladesh built its manufacturing and export powerhouse not just on cheap labor, but on a deliberate, state-driven strategy of creating dedicated export processing zones, ensuring energy security for industry, and building efficient logistical infrastructure like ports. This is a lesson in industrial policy, not monetary policy.
The Strategic Outlook
Looking ahead, the path for Nepal’s economy is not preordained. The choices made in the coming 12-24 months by our policymakers will determine whether we descend into a prolonged period of stagflation or undertake the painful but necessary reforms for a sustainable recovery. Two broad scenarios emerge.
The first is the path of least resistance: the “Muddle Through” scenario. In this future, the NRB, succumbing to overwhelming political and private sector pressure, engages in aggressive and front-loaded rate cuts. The policy rate is slashed significantly in a bid to shock the credit market back to life. The immediate outcome would likely be a superficial and fleeting sense of relief. We would see a minor uptick in consumer lending—more auto and personal loans—and perhaps a slight increase in home loan applications from those on the margin. However, this would not trigger a broad-based private investment recovery. The fundamental issues—bank risk aversion, the NPL overhang, and weak business confidence—would remain unaddressed. The cheap money would likely find its way back into speculative activities, potentially reigniting asset bubbles in specific segments of the stock or land market, rather than funding new factories. This consumption-led bump, not backed by domestic production, would fuel a surge in imports, widening the current account deficit and placing renewed pressure on our precious foreign exchange reserves. All the while, with supply-side bottlenecks unresolved, inflation would remain stubbornly high. The NRB would have expended its monetary firepower for a temporary sugar rush, leaving it with fewer options to manage the inevitable next crisis.
The second, more arduous path is that of “Structural Realignment.” In this scenario, the NRB holds its nerve, pursuing a cautious, data-driven approach to monetary easing while loudly and clearly communicating that its tools are at their limit. The real action shifts to the government and regulatory bodies. This path involves specific, courageous, and politically difficult reforms. To unfreeze the credit markets, the government, in partnership with the NRB, would need to establish a framework for a dedicated Asset Management Company (AMC) or “bad bank.” Such an entity would be empowered to buy the largest NPLs, particularly in real estate, from commercial banks at a negotiated, realistic price. This would crystallize losses but would clean bank balance sheets, freeing their capital and their risk appetite to lend anew. To revive manufacturing, policy would shift from cheap credit to creating a genuinely competitive industrial ecosystem. This means establishing fully-functional Special Economic Zones (SEZs) with guaranteed, uninterrupted power at competitive tariffs, and a true single-window system that handles all permits—from registration to environmental clearance—within a legally mandated timeframe. It requires a radical overhaul of public procurement to favor domestic manufacturers and a bold infrastructure drive focused on reducing transport costs. In this scenario, the Ministry of Finance takes the lead by dramatically improving the quality and execution rate of its capital expenditure, creating genuine economic demand and multiplier effects that monetary policy alone cannot achieve.
The hard truth for Nepal’s business leaders and policymakers is this: the Governor of the Nepal Rastra Bank is being asked to use a screwdriver to hammer a nail. For years, we have relied on monetary policy and the banking sector to solve all our economic problems, a burden they are no longer equipped to bear. The tightrope walker is exhausted, and the balancing pole is bending. The most critical economic decisions for Nepal’s future will not be made in the NRB’s boardroom. They will be made in the ministries that must dismantle cartels, in the parliament that must pass laws to facilitate industrial land acquisition, and in the cabinet that must have the political will to resolve the zombie asset crisis. Without this fundamental structural shift, we are simply choosing which side of the canyon to fall into.
