Nepali Times
Nation
Waiting game


SUVAYU DEV PANT


MIN RATNA BAJRACHARYA
Nepal's macro-economic situation is being buoyed by remittances, but monetary authorities seem unable to control galloping inflation.

All they can do is for Indian prices to drop, but an abnormal monsoon means food prices will remain high. The real reason for the inflation is cartelling, hoarding and general lawlessness in the country, and these are not likely to be resolved soon.

And the aftereffects of the global recession on remittances and tourism means even the traditional safety valves will not be able to rescue the ailing economy.

Price movements in Nepal and India tend to correspond because of import dependence and the fixed exchange rate. But Nepal's inflation is declining far more slowly than Indian inflation. This suggests that Nepali firms have colluded to keep prices up, which has aggravated the impact of transport bandas and political disruption.

"There isn't enough competition and too much cartelling in Nepal," is the conclusion of the IMF's man in Nepal, Alexander Pitt.

Recent police raids have revealed rife hoarding, but this doesn't explain inflation since hoarding causes discrete jumps in price and not the continuous rise Nepalis have witnessed.

Inflation occurs when the public spends too much or the money supply is too high. Monetary authorities can check inflation by selling bonds to the public, which takes money out of the economy, or buying bonds, which infuses money into it. When the money supply falls the interest rate rises, which in turn makes loans more expensive so reduces expenditure.

However, the peg to the Indian rupee means that NRB must surrender control over domestic inflation to its Indian counterpart. The NRB maintains the peg by manipulating the interest rate so can't change the money supply to control inflation as that would alter the interest rate and disturb the peg. This means that Nepal's monetary policy must broadly track India's.

But the dependence on India isn't a bad thing since NRB isn't well enough equipped to run an independent monetary policy and the peg has served to calm economic instability here. Plus, Nepal's close economic ties with India is a good reason to keep the peg.

When the NRB has tried to rein in inflation by increasing the interest rate and Cash Reserve Ratio, which requires banks to withhold money from the public, the results have been discouraging. Generally, monetary policy in Nepal hasn't effectively controlled inflation.

One reason is that Nepalis don't save money in banks or take out loans, so neither the CRR nor bank rate affects them directly. In technical parlance Nepal's economy is not "monetised".

NRB also can't control the Indian currency that circulates widely in Nepal. So there is little the central bank can do except to wait for Indian inflation to abate.

"Yet, the Rastra Bank behaves as if they can control all inflation," says monetary economist Raghab Dhoj Pant. Other bodies could step in to control cartelling by establishing a competition board and lower prices.

Reports of a liquidity crunch, which would curb inflation by throttling the money supply, have been wildly exaggerated, says Pant.

Nepal needs foreign exchange reserves to buy and sell currency so NRB can maintain the peg and let Indian prices drag Nepali prices down.

Remittances, which contribute 18 per cent to Nepal's economy, have ensured that Nepal has sufficient reserves. But some are worried that reserves will dry up as foreign economies reel under the current global crisis.

Nepali workers abroad send back foreign-denominated earnings, which pack extra purchasing power now that the Nepali rupee is weak, and this has caused remittance flows to register a 55 per cent spike this year. But this is likely to drop.

Any fall in remittance will be counterbalanced to some extent by a fall in the imports they finance, so experts think reserves will stay stable.

But a drop in remittance could hurt the financial and real estate sectors. Since land is often used as collateral, if land prices drop when remittance dips then banks wouldn't be able to recoup their investments, which could trigger a US-style liquidity crisis.

While inflation can be controlled if reserves stay up and cartelling is curtailed, some believe the government's target of reducing inflation to 7 per cent for the next fiscal year is too ambitious.

Says Pant: "It is a wish from never-never land."

READ ALSO:
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A visible hand - FROM ISSUE #462 (31 JULY 2009 - 06 AUG 2009)
Too little too late? - FROM ISSUE #462 (31 JULY 2009 - 06 AUG 2009)
Risky business - FROM ISSUE #462 (31 JULY 2009 - 06 AUG 2009)



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