The Conundrum Of Excess Liquidity : May 2012

The conundrum of interest rate and liquidity in the Nepali financial system is ceaselessly illogical and unpredictable, to say the least. The capital base of the banks and financial institutions (BFIs) is so awkwardly mid-sized, which is neither sufficient to finance any large project nor is the excess liquidity worth even a few billion rupees easily absorptive to the system. At present, BFIs are saying that they are in excess of some Rs 80 billion thus are announcing the cuts in the interest rates. One of the reasons of such reduction is the lack of demand of funds from the businesses, specially of those size suitable to the lending capacity of the BFIs.

The riddle becomes trickier when one looks into the demandsupply scenario of the funds in the major cities, let alone the farflung areas devoid of formal financial services. It is perhaps the time when the usury in the informal money market is at its peak. Very widely applicable interest rate in these markets at present is between 30 to 50 percent per annum. And, there are people ready to borrow any amount you name. More interestingly, these loans are seldom defaulted. Very recent central bank study has estimated that some Rs 5 billion change hands through the dhukuti (collection and lending in a small and informally organized group) business. Interest rates in these transactions are generally above 50 percent.

This is indicative of the fact that there is demand of funds in the market, but BFIs are unable to tap into this clientele. Conversely, there is fund in the BFIs, but the people who are borrowing such high rates are not reaching or do not have access to lending services of the BFIs. For both, inching out of traditionally comfortable risk parameters is still an untreadable zone. BFIs are naturally unable to invest even in medium sized projects, say 200 MW hydropower plant which generally costs some Rs 40 billion, for lack of fund.

The story of excess liquidity at this point is even more worrisome, because the system is experiencing it when the government's capital expenditure is limited to just about 25 percent of allocation, even after 9 precious months of the fiscal year slipped away.

There has not been any systematic study of the cash bulging, but the guess is: public confidence in the banking system is gradually returning after perhaps all-time low during 2009-2010. The banking system now appears complacent with the 'comfortable' liquidity position after a long period of crunch, but it may have many serious ramifications if the system as a whole in general and central bank in particular do not timely think of plugging in holes opened to the risky cliff. The comfort in liquidity has again shown signs of triggering new bouts of speculation in the real estate sector.

To recall, it was tightening of the noose by the central bank back in 2009 that had constricted the business of the properties, and thereby the economy. The prices of the properties that had stagnated in lack of financing to the potential clients could now become the baseprice and transactions are likely to augment. This means, the earlier speculative prices now get validated and new speculation begins building on that price, which indeed poses a new series of systemic risk.