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THE 91-DAY Treasury Bill in Nepal now yields 2.64% or so, down from 10.66% in 2021-22, according to fresh data released by the Nepal Rastra Bank. Over eighteen months the central bank has dismantled interest rates with a zeal rarely seen in South Asia. The 364-day T-bill sits at 2.72%. The interbank rate is 2.73%. Commercial banks have cut their base rate to 4.88%, from 6.09% a year ago. These numbers represent a historic low. They also represent a wall.
The central bank did not arrive at 2.64% by choice alone. It was pushed there by a deluge of foreign exchange. Remittances have transformed Nepal’s balance of payments from a deficit in 2021-22 to a surplus in 2023-24. Every dollar the NRB buys to maintain the rupee’s peg to the Indian currency injects rupees into the banking system. With deposits swelling to Rs8.012trn and broad money growing at 14.2% year on year, the system drowned in cash. The central bank cut rates to prevent the interbank rate from falling to zero.
The result is a yield curve that has flattened into a straight line. The gap between the 91-day T-bill at 2.64% and the 364-day T-bill at 2.72% is just eight basis points. The market prices no expectation of rate changes over the next year. It also prices no compensation for inflation risk over a twelve-month period. This is what exhaustion looks like.
More striking is the inversion at the short end. The interbank rate of 2.73% tops the 91-day T-bill rate of 2.64%. In a functional market overnight lending should cost less than a three-month government security. That it does not in Nepal tells something: banks hold so much excess liquidity that they are buying T-bills simply to offload cash, driving yields below the cost of overnight money. The 2.64% is an artificial floor created by a liquidity tsunami hitting a finite supply of government paper.
The transmission mechanism from these low rates to the real economy has broken down. Private sector credit grew at just 6.4% year on year. Against 14.2% money supply growth and Rs8trn in deposits, this is a profound failure of monetary policy to reach borrowers.
Businesses are not borrowing because they do not see demand. Real GDP growth is 3.9%. There is no organic consumer demand to justify expanding production capacity. Inflation, meanwhile, is driven by supply shocks rather than demand pressures. The wholesale price index has spiked, far outpacing the consumer price index. Businesses need credit just to cover rising input costs, not to invest in new capacity. Cutting the policy rate did not change these ugly realities.
The divergence between broad and narrow money confirms the blockage. Narrow money, or M1, grew faster than broad money. This means cash and highly liquid checking deposits are accumulating. Businesses and individuals are holding money in short-term forms, waiting for clarity. They are not locking funds into long-term time deposits, nor are banks locking them into long-term loans. The economy suffers from acute liquidity preference: the desire to hold cash rather than invest it.
For savers the low rates have produced a punishing outcome. The weighted average deposit rate is 3.29%. Consumer price inflation is 5.22%. The real return on a bank deposit is therefore negative. Every rupee kept in a bank account loses nearly 2% of its purchasing power a year. This invisible tax falls hardest on the growing middle class, retirees and institutional funds that rely on fixed-income returns.
The actual penalty is worse than the CPI suggests. The wholesale price Index, which measures the raw cost of inputs, has reached 8.47%. For a business borrowing at 6.64% to buy raw materials rising at 8.47%, the real cost of capital is staggeringly negative. The business is mathematically guaranteed to lose money on the spread alone before factoring in labour or overhead.
Commercial banks are caught in a structural vice. They pay depositors 3.29% while the safest investment, the 91-day T-bill, yields 2.64%. Matching assets and liabilities at the short end produces an immediate loss of 65 basis points. To survive, banks must lend to the private sector at 6.64%, earning a gross spread of 3.35%. This sounds healthy until one accounts for operating costs of roughly 2.5-3% of assets and the constant threat of non-performing loans in a stagnant economy. The margin for error is vanishingly small.
If the NRB were to push T-bill yields below 2.64%, it would drag down the entire yield curve. Banks would be forced to lower deposit rates further to protect margins. But deposit rates have a psychological and competitive floor around 3%. If deposit rates cannot fall and T-bill yields fall further, bank profitability vanishes. Without profitability, banks cannot build capital buffers. Without capital buffers, the financial system becomes unstable. The 2.64% floor is the minimum mathematical threshold required to prevent commercial banks from slipping into systemic losses.
The external constraint is even harder. Nepal pegs its currency to the Indian rupee. Under a fixed exchange rate regime, interest rates must broadly track those of the anchor country. If they diverge significantly, capital flows to the higher-yielding market and pressure builds on the peg. India’s central bank has kept policy rates relatively elevated to fight inflation. Nepal has slashed rates to 2.64%. The differential is already wide.
Were the NRB to cut rates to 1.5%, the interest rate differential would become dangerous. Institutional investors would seek higher yields in Indian markets or dollar-denominated assets. Remittance earners might delay converting dollars into rupees, expecting devaluation. Capital controls exist, but leakages occur through under-invoicing of trade and informal transfer mechanisms like hundi. The NRB knows that 2.64% is the absolute limit it can push before the peg comes under speculative pressure.
The central bank holds $24.67bn in gross foreign exchange reserves, a formidable defence. Burning through reserves to defend a currency while simultaneously suppressing interest rates to zero would be economic malpractice. Those reserves are insurance against external shocks, not a resource to be squandered for a further 100 basis points of rate cuts that would have no positive impact on private sector credit.
Nepal has arrived at a pseudo-zero-lower-bound environment, an unusual condition for a developing economy. Monetary policy is exhausted. The NRB has fired its last bullet. Going forward, macroeconomic outcomes depend entirely on fiscal policy and big reforms. If the government cannot accelerate capital expenditure, and if it cannot fix the supply chains yanking up wholesale inflation, the economy will remain stuck regardless of interest rates.
The greatest risk is a sudden reversal. If global commodity prices remain elevated and push CPI towards 6 or 7%, the negative real rate becomes politically and economically unsustainable. If the NRB is forced to hike the 91-day rate from 2.64% to 4 or 5% over a short period, the banking system will be shocked. Government debt servicing costs will spike. Asset prices will correct brutally. The central bank cannot cut rates to fix the economy, and it cannot raise rates without triggering a banking crisis.
Nepal is stuck at the bottom. The only way out is not further rate cuts but fiscal expansion, supply-side deregulation and structural reform. The 2.64% floor is a message from the bond market to the government. Monetary policy has done all it can. The rest is up to you. ■
