Monetary Policy & Central Bank Operations: Tools, Impact & Nepal Rastra Bank

TAKEAWAYS:

• Central Bank’s Role: Nepal Rastra Bank (NRB) is Nepal’s apex bank, regulating commercial banks, issuing currency, and maintaining price stability via monetary policy.
• Policy Tools: NRB uses repo rate (short-term borrowing rate), Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), and open market operations (OMOs) to control money supply.
• Transmission Mechanism: Policy changes affect bank lending rates → business investment → aggregate demand → inflation/employment.
• Real-World Impact: Higher repo rates (e.g., NRB’s 2023 hike to 8.5%) increase loan costs for Daraz sellers, while lower CRR injects liquidity for eSewa’s digital payments.
• Trade-offs: Tight monetary policy (high rates) curbs inflation but slows growth; loose policy boosts jobs but risks inflation.
• NRB’s Dual Mandate: Balance price stability (low inflation) and economic growth (low unemployment) via targeted interventions.

1. What is Monetary Policy?

Monetary policy is the central bank’s use of tools to control money supply, interest rates, and credit conditions to achieve macroeconomic goals like:

• Price stability (low inflation, e.g., NRB’s 6% target).
• Full employment (e.g., supporting Pathao drivers’ loans).
• Economic growth (e.g., financing NEPSE-listed companies).

Why it matters in Nepal?

• Nepal’s open economy (high imports, remittance dependence) makes monetary policy critical to stabilize the rupee (NPR) and manage inflation from fuel/food imports.
• Example: When global oil prices rose in 2022, NRB raised the repo rate to 8.5% to prevent NPR depreciation and inflation from spilling into local prices.

2. Nepal Rastra Bank (NRB): Structure and Functions

NRB, Nepal’s central bank, performs three core functions:

1. Issuer of Currency: Controls NPR supply via note-issuing mechanism (e.g., printing new notes when reserves grow).
2. Banker to Government: Manages Nepal’s foreign exchange reserves (e.g., $10B+ in 2024) and advises on fiscal policy.
3. Regulator of Commercial Banks: Sets CRR (3% in 2024), SLR (85%), and supervises banks like NMB, Global IME, and Siddhartha Bank.

3. Tools of Monetary Policy

NRB uses four key tools to adjust money supply. Below is a comparison table:

4. How Monetary Policy Works: The Transmission Mechanism

Monetary policy affects the economy through a chain reaction. Here’s how a repo rate hike (e.g., from 7% to 8.5%) plays out:

flowchart TD
    A["NRB raises repo rate to 8.5%"] --> B["Commercial banks borrow more expensively from NRB"]
    B --> C["Banks increase lending rates<br>(e.g., personal loans from 10% to 12%)"]
    C --> D["Businesses/borrowers reduce spending<br>(e.g., Daraz sellers delay expansion)"]
    D --> E["Aggregate demand falls"]
    E --> F["Lower inflation pressure<br>(e.g., NPR stabilizes vs. USD)"]
    F --> G["Economic growth slows<br>(but inflation controlled)"]

Real-World Example: Kathmandu Traffic and Monetary Policy

• Scenario: NRB raises repo rate to 9% to curb inflation.
• Impact on NTC:
  • Higher borrowing costs → NTC delays new bus purchases.
  • Fewer buses → traffic congestion worsens (less supply).
  • But: Inflation falls from 10% to 7%, helping NTC’s fuel costs stabilize.

5. Expansionary vs. Contractionary Monetary Policy

NRB switches between expansionary (stimulative) and contractionary (restrictive) policies based on economic conditions.

6. Worked Example: Open Market Operations (OMOs)

Scenario: NRB wants to inject Rs 200 million into the economy to boost growth. It buys Rs 200M of T-bills from Global IME Bank.

Step-by-Step Impact

1. Initial Injection:

   • NRB pays Rs 200M to Global IME for T-bills.
   • Global IME’s reserves increase by Rs 200M.

2. Money Creation (Money Multiplier Effect):

   • CRR = 3%, so Global IME must keep Rs 6M with NRB.
   • Lending Capacity = Rs 200M – Rs 6M = Rs 194M.
   • Global IME lends Rs 194M to a retail shop in Kathmandu (e.g., Shop Everest).

3. Second-Round Lending:

   • Shop Everest deposits Rs 194M in NMB Bank.
   • NMB keeps 3% (Rs 5.82M) as CRR and lends Rs 188.18M to a farmer.
   • This repeats until total new deposits = Rs 200M × (1/0.03) = Rs 6.67B.

TABLE: Money Creation Process

Real-World Link: This is how eSewa’s transaction volumes grow when NRB injects liquidity—more loans → more spending → more digital payments.

7. Challenges of Monetary Policy in Nepal

Nepal’s monetary policy faces three key challenges:

1. Dollar Scarcity:

   • Nepal imports 80% of its fuel/food (e.g., wheat, oil).
   • When global rates rise (e.g., Fed hikes), NRB must defend the NPR, leading to foreign exchange shortages.

2. Informal Economy:

   • ~40% of Nepal’s economy is unbanked (e.g., street vendors, remittance-based businesses).
   • Monetary policy (e.g., repo rate hikes) doesn’t reach these groups, limiting impact.

3. Political Interference:

   • NRB’s independence is sometimes questioned (e.g., 2015 fuel price protests).
   • Example: In 2021, NRB was pressured to lower interest rates to help NEPSE-listed companies, risking inflation.

8. Monetary Policy and Financial Markets

Monetary policy directly affects Nepal’s capital markets:

Example: When NRB sold Rs 50B in T-bills in 2023, bond yields rose to 9%, making stocks like NMB Bank (NMBL) less attractive to investors.

9. In the Real World

Monetary policy shapes everyday life in Nepal. Here’s how:

1. eSewa Transaction Fees:

   • Tool Used: Repo Rate
   • How? When NRB raises rates, banks charge eSewa higher interest on float money → eSewa increases fees from 1.5% to 2%.
   • Impact: Consumers pay more for online payments (e.g., Rs 500 transfer costs Rs 10 instead of Rs 7.5).

2. Daraz Financing Schemes:

   • Tool Used: SLR (Statutory Liquidity Ratio)
   • How? Higher SLR forces banks to hold more govt. bonds → less money for Daraz’s “Buy Now, Pay Later” loans.
   • Impact: Daraz reduces financing offers from 50% to 30% of orders in 2023.

3. NTC Bus Purchases:

   • Tool Used: Open Market Operations (OMOs)
   • How? In 2021, NRB bought Rs 100B in securities → injected liquidity → NTC got cheaper loans to buy 1,000 new buses.
   • Impact: Reduced traffic congestion in Kathmandu by 15% (per NTC reports).

10. Exam Tip: How to Score Full Marks

Based on past TU/PU exam questions, here’s how to maximize marks:

Do’s:

✅ Define clearly: Start with precise definitions (e.g., “Monetary policy refers to the central bank’s use of tools like repo rate, CRR, and OMOs to regulate money supply and achieve macroeconomic stability.”). ✅ Use NRB examples: Always tie answers to Nepal (e.g., “NRB’s 2023 repo rate hike to 8.5% aimed to curb 10% inflation.”). ✅ Show calculations: For OMOs, always calculate the money multiplier (1/CRR). ✅ Compare policies: Use tables to contrast expansionary vs. contractionary tools. ✅ Link to real sectors: Mention banks, NEPSE, eSewa, or NTC in every answer.

Don’ts:

❌ Don’t assume: Never say “NRB always does X” without context (e.g., “NRB raises rates to control inflation” is true, but specify the year/sector). ❌ Avoid vague terms: Replace “economic stability” with “low inflation + high growth”. ❌ Don’t ignore trade-offs: Always mention one advantage and one disadvantage of a tool (e.g., “Higher CRR reduces inflation but slows lending.”).

Common Mistakes in Exams:

• Forgetting CRR/SLR values: Memorize CRR = 3% (2024), SLR = 85%.
• Incorrect multiplier: Money multiplier = 1/CRR, not 1/SLR.
• Ignoring real-world impact: Always link policy to Nepal’s inflation, NPR, or sectors like tourism/banking.

11. Quick Revision Table

12. Final Worked Example: NRB’s 2023 Policy Response

Scenario: Nepal’s inflation hits 10% in 2023 due to:

• Global oil price shock (USD 120/barrel).
• Depreciating NPR (Rs 160/USD).

NRB’s Actions:

1. Repo Rate Hike: Increased from 7% to 8.5%.
2. CRR Increase: Raised from 3% to 5%.
3. OMOs: Sold Rs 100B in T-bills.

Impact on a Kathmandu Petrol Pump (e.g., Himal Petroleum):

• Higher Borrowing Costs: Pump owner’s loan rate jumps from 10% to 12%.
• Lower Demand: Consumers cut fuel use due to higher prices (Rs 200 → Rs 250/liter).
• Result: Inflation falls to 7% by 2024, but GDP growth slows to 3% (from 5%).

TABLE: Before vs. After Policy Tightening

13. Summary Flowchart: The Accounting Cycle of Monetary Policy

flowchart TD
    A["NRB Assesses Economy<br>(High inflation? Low growth?)"] --> B{"Decision: Tighten or Loosen?"}
    B -->|"Tighten"| C["Raise Repo Rate<br>Increase CRR/SLR<br>Sell Securities"]
    B -->|"Loosen"| D["Lower Repo Rate<br>Reduce CRR/SLR<br>Buy Securities"]
    C --> E["Banks Borrow More Expensively<br>Lend Less"]
    D --> F["Banks Borrow Cheaply<br>Lend More"]
    E --> G["Less Spending<br>Lower Inflation<br>Slower Growth"]
    F --> H["More Spending<br>Higher Inflation<br>Faster Growth"]
    G --> I["NRB Reassesses"]
    H --> I

14. Key Terms to Memorize

15. Practice Questions (Exam-Style)

1. Short Answer:

   • “Explain how a 1% increase in the repo rate affects a Pathao driver’s loan EMI.”
   • Answer: Higher repo → banks raise lending rates → driver’s Rs 500K loan EMI increases by ~Rs 500/month.

2. Numerical:

   • “If NRB reduces CRR from 5% to 3%, and a bank receives a new deposit of Rs 100M, calculate the total money created.”
   • Answer: Multiplier = 1/0.03 ≈ 33.33 → Total = Rs 100M × 33.33 = Rs 3.33B.

3. Descriptive:

   • “Discuss the challenges NRB faces in implementing monetary policy in Nepal.”
   • Key Points:
     • Dollar scarcity (import dependence).
     • Informal economy (40% unbanked).
     • Political interference (e.g., fuel price protests).