IMAGE VIA GOOGLE
WHEREAS MOST central bankers lie awake worrying about running out of money, Nepal’s has the opposite problem: it does not know what to do with a surfeit of it. By the end of last year foreign-exchange reserves had swollen to an eye-watering $22bn, enough to cover 18 months of imports. That is triple the standard benchmark and double the country’s own target.
On paper the balance sheet looks formidable. On the streets of Biratnagar or Birgunj, however, the economy is wheezing. Prices are barely rising. Bank lending has stalled. Young people still queue for permits to work abroad. Nepal is a poor country that has accidentally become rich in the wrong way.
That mountain of cash is a symptom of stagnation. For a developing nation, hoarding such vast reserves is a policy failure of the first order. The opportunity cost is enormous. While the money sits in low-yielding American bonds, the domestic economy is gasping for air. Inflation has fallen to just 1.6%. In a booming economy, that might be cause for celebration. In Nepal it is a klaxon of collapsing demand. People are not spending because they are not there, or because they lack the confidence to do so. Private-sector credit grew by a miserable 1.9% in the first five months of the fiscal year. Banks are awash with liquidity yet borrowers refuse to bite.
Remittances are the engine of this imbalance, having surged by over 30% in recent months. That creates a self-perpetuating loop that is as stable as it is destructive. A lack of jobs at home pushes the young abroad. Their families send back money, which gets deposited in banks. The central bank mops up the foreign exchange to maintain the currency’s peg to the Indian rupee. But because the investment climate is poisoned by political instability and thickets of red tape, that money never reaches factories or farms. It stays in the vault. Nepal is exporting its future to fund a current-account surplus.
To see why this is a failure, consider what that money could be doing instead. Economists talk of the “precautionary motive” for reserves, a shield against a sudden trade shock or a spike in oil prices. But a shield that is twice as heavy as the soldier can carry is a burden. At 18 months of import cover, the insurance benefit of an extra dollar is nil.
The social return on investing that dollar in a hydroelectric dam or a digital backbone would be vastly higher. Nepal is over-insured to the point of absurdity. Excessive prudence is growth-destructive. It starves the domestic market of the very capital needed to reduce reliance on imports in the long run.
Compare Nepal with Singapore, a city-state with a gift for foresight. Singapore does not let its excess reserves sit idle. It separates them. The monetary authority keeps what is needed for stability. The rest is handed to GIC, a sovereign wealth fund, and Temasek, a state-owned investment firm, to be put to work. That calls for a governance firewall that Nepal lacks. The cautionary tale is Bangladesh. A few years ago it used its reserves for an export fund and infrastructure. But a lack of oversight and a global price shock saw those reserves disappear with terrifying speed. The lesson for Kathmandu is that the money must be used, but only through institutions insulated from the sticky fingers of the political class.
A lack of “integrity capacity”—on plain display in the oversight of cooperatives and real estate—is the main obstacle. Nepal is in the grey list of the Financial Action Task Force, the global money-laundering watchdog. Any attempt to create a sovereign wealth fund or a development bank using reserves would be viewed with suspicion by international markets unless it is accompanied by a radical cleaning of the house. The fear is that the reserves will become a slush fund for the well-connected. This is the risk trap: even with abundant funds, investment fails because the perceived risk of policy reversal or corruption is too high.
Yet the status quo is not tenable anymore. The central bank should move from passive hoarding to active “productive absorption”. That does not mean the government should spend the reserves on salaries or social transfers. That would be a recipe for a currency crisis.
Instead the focus should be on de-risking the private sector. Hydropower is an obvious target. Nepal has the potential to generate 28,500 megawatts of electricity by 2035. Developers struggle to get long-term foreign-currency loans to buy turbines and machinery. Using a portion of the excess reserves to provide such credit would be a masterstroke. It would turn a dormant asset into a power-generating one that eventually earns its own foreign exchange through exports to India.
The information-technology sector is another candidate. It is a weightless export, indifferent to Nepal’s landlocked geography or crumbling roads. Recent laws have finally allowed Nepali IT firms to invest abroad and open branches. A venture-capital fund backed by the surplus reserves could provide the bridge for them to scale up.
Likewise the country spends billions every year importing chemical fertilisers. A large-scale urea plant, financed through a public-private partnership and backed by a sovereign investment vehicle, would transform an import liability into a domestic asset. That is how you use reserves to build resilience, rather than just buying insurance against its absence.
For this to work, the Nepal Rastra Bank must maintain a “reserve adequacy floor”. Six or seven months of import cover should be treated as sacrosanct. Anything above that should be moved into a separate, professionally managed fund, operating under the transparency of the Santiago Principles, with a mandate for long-term commercial returns and audits by international firms. That would prevent “fiscal dominance”—the government treating the central bank as its personal ATM. The goal is to separate the stability of the currency from the development of the nation. One handles the anchor; the other handles the engine.
The political economy of a remittance-dependent state tends to favour the status quo. Fat reserves provide a safety valve that allows policymakers to ignore difficult reforms. As long as dollars keep flowing in from the Gulf, there is no urgent pressure to fix the broken bureaucracy or the predatory tax system. The surplus reserves mask the underlying decay of the domestic economy. By refusing to deploy the capital, the state is implicitly accepting that exporting its people is the only viable economic model. It is a vote of no confidence in its own future.
Nepal’s fortress balance sheet is a luxury it cannot afford. A nation with such high poverty and such low infrastructure cannot justify being a net creditor to the developed world by holding billions in American Treasury bills. The irony is that the safety the central bank seeks through hoarding is an illusion. True safety comes from a diversified, productive economy that can withstand shocks because it produces things of value. A pile of cash is a buffer, but it is not a strategy. The excess reserves are a one-time opportunity to break the cycle of migration and stagnation.
The task now is to build the pipes that can carry this liquidity into the parched fields of domestic industry. That requires a new compact between the state and the private sector. It requires a central bank brave enough to lead and a government honest enough to stay out of the way. If Nepal continues to sit on its treasure, it will find that while the vault is full, the country has become an empty shell.
The most successful central banks are those that eventually become boring because the economy they oversee has become exciting. It is time for the Nepal Rastra Bank to start the process of making itself a little less important and the Nepali economy a lot more productive. ■
