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The crisis adds to the inflation that is a result of the state's enforcement failure. No financial common sense or market logic has answers to the reasons behind the liquidity crisis. Neither does Nepal Rastra Bank (NRB) seem overly concerned about the situation, and its ability and willingness to deal with the problem remains questionable. It has said the crisis will persist for at least two more months: until the first consignment of the newly printed notes arrives from France.
The currency crunch is the cumulative outcome of mainly three factors. First, the Voluntary Disclosure of Income Scheme (VDIS) and disclosure of income source made mandatory by the Maoist government is believed to have driven about Rs 10 billion in cash off the market.
People chose to stash cash in private coffers. In hindsight, the benefit of economies of scale created by this Rs 10 billon would have been much larger than over-trumpeted success of VDIS that netted a mere Rs 1.5 billion.
Second, the oversubscription of IPOs of mainly Class A banks halted the circulation of several billion rupees for a couple of months, as was the case of Sunrise Bank holding about Rs 10 billion this time around. Also, people may maintain substantial contingency of cash reserve for other IPOs, like Prime Bank.
Third, the unresponsiveness and unwillingness of the government to resolve the problem, and underlying vested interest of the NRB leadership have exacerbated the situation. Had the regulatory authorities wanted, one well-meaning notice would have been sufficient to bring the hoarded amount to the banking system. Instead, NRB seems to think the solution is to print the new notes and bring them in to circulation as soon as possible.
Interestingly, the currency shortage provides an excuse and opportunity for NRB leadership to print new currency notes. It decided to print about 100 million units of new notes mainly of Rs 500, but without much justification. The market and commercial activities have not substantially expanded. Even with Rs10 billion in cash going out of circulation and the 10 per cent annual growth, the aggregate requirement does not exceed Rs 24 billion.
There are enough reusable notes stockpiled, so the current liquidity crisis could be orchestrated. Be that as it may, but there is a tendency of printing more than required amount of currency notes under different pretexts, especially when a new governor is appointed during periods of shaky politics.
The term of present governor Dipendra Kshetry ends on 2 February 2010, but he may even have to quit early if the Supreme Court reinstates the suspended governor Bijaya Nath Bhattarai. The next hearing on the case is scheduled for 31 May. Kshetry also has the politically-correct excuse of not circulating old notes carrying the portraits of former kings and printing replacements.
As a short term redress, NRB released Rs 2 billion through open market operations last Monday when the inter-bank rate touched 10 per cent and there was no 'investible' liquidity with the banks. The issue of shortage and printing of new bills aside, the reason given by NRB as 'lack of investible liquidity' point to other graver problems in the economy. The recent competition among the banks to attract the depositors by offering higher interest rates implies more than a shortfall in the circulation cycle.
This may be indicative of a decrease in deposits and decline in the repayment of the loans. A significant amount could also be clogged up in unproductive sectors like real estate, and immediate return from this type of investment is unlikely.
In this scenario, the economy may plunge into a contraction trap. The government, regulatory authorities and the financial market should try to address the real problems jointly instead of deflecting them as a temporary defect in money supply.
