Q1 monetary policy review signals weak recovery, Rising credit stress, and structural limits to growth

KATHMANDU: The First Quarter Review of the Monetary Policy 2082/83 released by Nepal Rastra Bank (NRB) paints a picture of an economy recovering slower than anticipated, weighed down by weakening domestic demand, subdued private investment, and a fragile credit environment. The central bank’s analysis underscores that while inflation has eased and liquidity appears comfortable, the underlying economic engine remains underpowered, revealing deeper structural weaknesses in Nepal’s financial and real sectors.

The review serves as a critical signal to investors, businesses, development partners, and financial institutions that Nepal’s current macroeconomic equilibrium—characterized by low credit expansion, rising non-performing loans, and mild external stability—is not driven by growth, but rather by suppressed economic activity and cautious financial behavior.

Inflation Down, But Demand Has Fallen for the Wrong Reasons

Headline inflation is moderating, supported by stable imports, improved supply chains, and subdued fuel prices globally. While this aligns Nepal with global disinflationary trends seen in South Asia and emerging markets, the central bank notes that the decline in inflation is not driven by productivity or income expansion, but by weakening household purchasing power.

Consumption indicators across food, retail, and non-food items show that consumers are cutting back, not benefitting. This type of disinflation—“weak-demand disinflation”—tends to prolong economic sluggishness, as businesses reduce production, limit hiring, and postpone investment.

This pattern closely resembles post-pandemic consumption behavior in several low-income economies, where recovery slowed due to stagnating real incomes and limited fiscal stimulus.

Slow Credit Growth Reflects Deep Stress in the Private Sector

The private sector—the engine of Nepal’s employment, FDI, and tax revenue—continues to struggle. Credit to the private sector grew only 1.46%, one of the weakest Q1 expansions in a decade.

Despite surplus liquidity in the banking system, businesses are not borrowing because:

Demand is low, reducing the incentive for expansion.

Profitability has declined, making loan servicing difficult.

Costs remain high, from wages to imported inputs.

Bankers are risk-averse, given rising NPLs.

Key sectors face severe credit stress:

Manufacturing: Still reeling from high input costs and suppressed demand.

Construction: Hit by delays in public projects and lower private real estate activity.

SMEs: Struggling the most, with cash-flow shortages and falling sales.

Tourism-linked businesses: Hiring more but still operating below profitability thresholds.

Rising non-performing loans signal deeper fragility. When NPLs rise during low interest-rate phases and high liquidity, it means firms are fundamentally weaker than balance sheets suggest.

Deposit Growth Outpaces Credit: A Classic Sign of Economic Anxiety

Deposits grew faster than loans across commercial banks, development banks, and finance companies. This signals:

Households prefer saving over spending.

Businesses are holding cash instead of investing.

Financial institutions are risk-averse.

The overall economy is in “precautionary mode.”

In a vibrant economy, deposits convert into credit, credit becomes investment, and investment becomes jobs. Nepal is currently trapped in the opposite cycle.

External Sector Stable, But Not Because of Export Strength

Nepal’s improving external position—higher reserves, manageable deficit, strong remittances—may initially seem like a macroeconomic win. But the review reveals the real driver:

Import contraction, not export expansion.

This mirrors the slowdown in domestic investment and production. Exports remain constrained by:

High logistics costs

Lack of product diversification

Limited industrial competitiveness

Dependence on few markets

South Asian economies like Bangladesh, India, and Sri Lanka have expanded export-led sectors aggressively in the past decade. Nepal, in contrast, relies on remittances and import suppression, which helps stabilize the external sector but fails to generate sustainable growth.

Industrial Output Weak; Service Sector Driving Partial Recovery

The review highlights:

Industry: Weak performance, especially in construction materials, manufacturing, and energy-intensive activities.

Agriculture: Benefited from favorable weather but still lags due to productivity challenges.

Services:

Tourism, hospitality, and aviation show improved momentum.

IT, telecom, and digital services expand steadily.

Retail trade remains subdued.

This shift toward service-led recovery is positive but insufficient for structural transformation. Without industrial growth and large-scale investment, Nepal cannot expand employment or boost long-term GDP potential.

Real Estate and Housing Loans Show Softness

Credit growth in real estate and housing—traditionally a strong driver of loan portfolios—has weakened. The review notes that:

Construction slowdown

Reduced land transactions

Rising project delays

Investor caution

have contributed to a decline in sectoral borrowing. This reduces consumption, reduces government revenue from land tax and registration fees, and slows related industries like cement, steel, and housing materials.

Regulatory Easing by NRB Indicates Policy Concern

The central bank introduced targeted regulatory relaxations, such as:

Loan restructuring/rescheduling options

Payroll protection renewal

Special refinancing for backward/forward linkages

Flexible provisioning for crisis-affected loans

Sector-focused credit guidelines

These measures reflect NRB’s recognition that businesses are struggling more deeply than headline numbers suggest. The central bank is attempting to prevent a credit crunch, support employment, and avoid widespread defaults.

However, these are temporary stabilizers—not long-term solutions.

Liquidity Surplus but Investment Scarcity: Nepal’s Paradox Deepens

Nepal currently exhibits a macroeconomic paradox:

Banks have liquidity surplus.

Interest rates are relatively stable.

But investment is not happening.

This reflects structural constraints:

Policy instability affecting investor confidence.

Chronic project delays in energy, roads, airports, and public infrastructure.

Uncompetitive tax and regulatory structures reducing private-sector appetite.

Weak export capabilities limiting growth multipliers.

Overreliance on remittances, masking domestic weaknesses.

This paradox weakens long-term economic prospects because liquidity alone cannot stimulate growth without a conducive investment climate.

Digital Finance Growing, but Financial Inclusion Still Uneven

The review highlights strong expansion in:

Mobile wallets

QR payments

Online banking

Digital settlement systems

The launch of a Systemically Important Payment Systems (SIPS) framework is a major milestone. It aligns Nepal with global digital finance standards and supports payment certainty, stability, and cybersecurity.

However, digital finance growth has not yet translated into stronger credit growth or enterprise development, indicating the need to integrate digital finance with productive-sector lending strategies.

Sovereign Rating and International Confidence: A Subtle Warning

Fitch reaffirmed Nepal’s BB- sovereign rating, but NRB’s review subtly warns of concerns in:

Political fragmentation

Fiscal consolidation

Slow public-sector execution

Weak medium-term growth outlook

The reaffirmation maintains global investor confidence but does not upgrade Nepal’s risk profile. Without strong reforms, Nepal risks slipping into a “low-equilibrium trap.”

Economic Implications: What the Review Really Signals

1. Growth Trajectory Is Flattening

NRB’s subdued tone indicates that the earlier growth projection (3.5%) may be cut if structural constraints persist.

2. Private Sector Stress Is Now Systemic

Rising NPLs, low credit demand, and weak sales show business balance sheets are strained.

3. Investment Climate Remains Fragile

Despite liquidity and low inflation, businesses are not investing—reflecting policy uncertainty.

4. Fiscal Weakness Will Intensify

Lower imports and slowing domestic activity mean reduced revenue for the government.

5. Nepal Risks a Long-Lasting Low-Growth Cycle

Unless investment picks up, Nepal may enter a multi-year period of subdued growth, resembling the stagnation seen in several low-income economies.

6. Employment Generation Remains a Major Risk

Small enterprises—Nepal’s main employers—are the most stressed, which may worsen youth unemployment.

7. External Sector Stability Is Temporary

Import contraction cannot support stability forever; growth requires export competitiveness.

8. Monetary Policy Alone Cannot Revive the Economy

NRB’s tools are limited unless complemented by: