Wednesday, December 24, 2014
Tuesday, November 4, 2014
Saturday, September 6, 2014
Excess liquidity: Pros and cons
he current excess liquidity in the banking system is more or less the replay of the story that hogged news headlines in 2009, but with different actors and the situation. In that sense, Nepal’s bumpy financial system has come to a full circle in the last five years, and moved to one extreme point from another. A quick flashback: In early 2009 Nepal’s financial system experienced an unprecedented shortage of liquidity. All that started with the hastily appeared huge mismatch between inflow of cash into the banking system in terms of deposits and loan repayments, and the outflow in terms of fresh credits.
There were three major reasons for the decline in the growth of deposits. First in the international front, the global financial crisis rattled the global economy the same year that squeezed the incomes of Nepali workers in the Gulf States and slowed the breakneck growth rate of remittance. Second in the domestic front, annoyed by the cold response to Voluntary Disclosure of Income Scheme (VDIS), the then Maoists government threatened to investigate bank accounts and sources of income of those not complying with the scheme. Third, the government announced a provision that required a valid source of income while depositing more than one million rupees in the banks.
All those set of actions badly sliced off depositors’ confidence, triggering two immediate impacts. First it slowed growth rate of individual deposits to 9 percent in 2009/10 from 32% recorded a year earlier. Second, it instigated a massive withdrawal of cash from the banks that according to some estimates was over Rs 12 billion. In contract, the outflow of the cash from the banking system in terms of fresh loans continued to grow at as much as twice of the deposit growth rate. As a result, Nepali financial market faced a severe shortage of liquidity. As a result, one-year deposit rate and the inter-banking lending rate, a quick barometer to gauge liquidity in the market, soared to over 12 percent.
Five year down the line, the situation is exactly opposite and the economy is struggling hard to manage excess liquidity. The cause of the problem is very straight. Last year’s exponential growth of over 26 percent in net current transfer, which includes remittance and pension incomes, hugely expanded money supply in the economy. As a result, Nepal witnessed an addition of Rs 233 billion in bank deposits whereas fresh credit expanded only by Rs 178 billion during the same period. As a result, the banking system added fresh liquidity worth Rs 55 billion on the top of around Rs 25 billion worth of liquidity it already had.
Similarly, huge government surplus remained one more reason for the excess liquidity. In the last year, total government income increased by 23 percent whereas total expenditure went up by 16 percent. As the result of government’s inability to expense available recourses on development works, the treasury ran into surplus of around Rs 30 billion. All these surpluses resources created a record liquidity of over Rs 100 billion in the banking system. Though the central bank lately used a new instrument to absorb Rs 20 billion, it is unlikely to make any remarkable impact given the hefty liquidity piled up in the banks.
Now the biggest question is what will be the impact of such a gigantic liquidity on the financial system. Some are already visible. The volume of interbank lending among the commercial banks squeezed to Rs 185 billion last year whereas such figure in the preceding year was Rs 726 billion. As a result, the interbank lending rate – the rate at which banks lend to reach other to manage quick cash imbalances -plunged to a record 0.22 percent whereas it was 2.72 percent in the pervious year. Similarly, weighted average rate on treasury bills plummeted to 0.13 percent. As the consequences, the average deposit rate declined to 4 percent but when official inflation rate, whose credibility is often questioned, was 8 percent last year. The negative interest rate – bank deposit rate minus rate of inflation - was 4 percent last year, which is at least 4 percent per year, is becoming a great disincentive for depositors to put their money in the bank.
This is the point when a time bomb starts ticking and that was how the infamous banking crisis hit Nepal’s financial system in 2009. The chain of reactions was very simple. In order to avoid negative interest rate and secure higher returns, depositors slowly lured towards highly risky speculative investments such as real estate and stock. Banks’ real estate lending and margin lending – lending against share certificate - increased by around 18 folds between 2006 and 2009. When the real estate and stock bubble burst in early 2010, putting at risk Rs 130 billion worth of bank investment, it shuck the very foundation of Nepal’ banking system. The blow to the banking system was severe that some of the banks are still trying hard to recuperate.
Against this backdrop, the continued negative interest rate is clearly an early warning that Nepal’s financial system is warming up for return to the baking crisis of 2010. As the amount of deposits continues to be higher than the lending, banks will continue to add up additional liquidity. In means, coming months will be more challenging in the sense that increased remittance will continue to swell money supply that will further increase rate of inflation and lower deposit rates along with the lending rates. The additional money supply during the Dashin festival might further worsen the situation.
The deadly combination of low deposit and lending rates along with the growing inflation will further provoke people toward risky speculative investments. Despite various restrictions enforced by the central bank to curtail real estate and stock lending, chances are high that both the sectors will see another bubble in coming months, albeit not in a scale seen before the 2010-banking crisis. And, chances are high that the cooperatives, which are in operation without strict regulatory policies and risk assessment mechanism, will be the inflator of the bubble. Despite some reputational issues, the cooperatives in recent times have been able to attract huge amount of deposits by offering deposit rate much higher than what the banks are offering. Though, Nepal badly lacks credible financial statistics on the finances of cooperatives, it is estimated that cooperatives have amassed huge deposits worth Rs 300 billion, one-fourth of deposits held by the banks. As the most of the banks are already close to the limit imposed by central banks on real-estate and stock lending, it is the cooperatives that will most likely emerge as the main real-estate lender after the upcoming festival, a pick season for land transactions. Undoubtedly, Nepal made wonderful efforts to consolidate regulations on the banking system and that produced appreciable results. By contrast, another slowly emerging player of the financial sector – cooperatives - remains in a sorry mess, mainly in terms of exercising financial prudency. No doubt, a major financial disaster is brewing there, but few people seem ready to pay due attention on the impeding risks.
Now the million-dollar question is: How to manage the swelling liquidity by preventing a possible huge flow of deposits from the banking system to cooperatives? One of the options available to deal with the excess liquidity is to lure additional investment to hydropower development by brining more investment friendly policies. It is because hydropower is probably the only sector that can absorb huge amount of liquidity with comparatively less risks, has a good prospect for both internal consumption and export, and has the potential to address the Nepal’s biggest impediment to growth. The recently announced policy to provide a lump-sum grant of Rs 5 million per megawatt is a right step in attracting investments to the hydropower sector.
However, unpredictable fluctuation in lending rates is still a discouraging factor. Many investors still recall the notorious rise in lending rate after the 2010-banking crisis. The rapid up to 5 percentage points rise in lending rate suddenly reversed the financial viability of the hydropower project. Such an unprecedented spike in lending rates badly tarnished investors’ confidence, compelling many to postpone the constructions activities. As one of the policy options to deal with such risks, the government should think of introducing a lending rate band - rate that can fluctuate between the upper and lower limits. The policy will help investors to predict the worst possible cost of lending and adjust returns and investments accordingly. The special refinance facility that the central bank has been administrating can be reformed to make such lending rate band workable.
There were three major reasons for the decline in the growth of deposits. First in the international front, the global financial crisis rattled the global economy the same year that squeezed the incomes of Nepali workers in the Gulf States and slowed the breakneck growth rate of remittance. Second in the domestic front, annoyed by the cold response to Voluntary Disclosure of Income Scheme (VDIS), the then Maoists government threatened to investigate bank accounts and sources of income of those not complying with the scheme. Third, the government announced a provision that required a valid source of income while depositing more than one million rupees in the banks.
All those set of actions badly sliced off depositors’ confidence, triggering two immediate impacts. First it slowed growth rate of individual deposits to 9 percent in 2009/10 from 32% recorded a year earlier. Second, it instigated a massive withdrawal of cash from the banks that according to some estimates was over Rs 12 billion. In contract, the outflow of the cash from the banking system in terms of fresh loans continued to grow at as much as twice of the deposit growth rate. As a result, Nepali financial market faced a severe shortage of liquidity. As a result, one-year deposit rate and the inter-banking lending rate, a quick barometer to gauge liquidity in the market, soared to over 12 percent.
Five year down the line, the situation is exactly opposite and the economy is struggling hard to manage excess liquidity. The cause of the problem is very straight. Last year’s exponential growth of over 26 percent in net current transfer, which includes remittance and pension incomes, hugely expanded money supply in the economy. As a result, Nepal witnessed an addition of Rs 233 billion in bank deposits whereas fresh credit expanded only by Rs 178 billion during the same period. As a result, the banking system added fresh liquidity worth Rs 55 billion on the top of around Rs 25 billion worth of liquidity it already had.
Similarly, huge government surplus remained one more reason for the excess liquidity. In the last year, total government income increased by 23 percent whereas total expenditure went up by 16 percent. As the result of government’s inability to expense available recourses on development works, the treasury ran into surplus of around Rs 30 billion. All these surpluses resources created a record liquidity of over Rs 100 billion in the banking system. Though the central bank lately used a new instrument to absorb Rs 20 billion, it is unlikely to make any remarkable impact given the hefty liquidity piled up in the banks.
Now the biggest question is what will be the impact of such a gigantic liquidity on the financial system. Some are already visible. The volume of interbank lending among the commercial banks squeezed to Rs 185 billion last year whereas such figure in the preceding year was Rs 726 billion. As a result, the interbank lending rate – the rate at which banks lend to reach other to manage quick cash imbalances -plunged to a record 0.22 percent whereas it was 2.72 percent in the pervious year. Similarly, weighted average rate on treasury bills plummeted to 0.13 percent. As the consequences, the average deposit rate declined to 4 percent but when official inflation rate, whose credibility is often questioned, was 8 percent last year. The negative interest rate – bank deposit rate minus rate of inflation - was 4 percent last year, which is at least 4 percent per year, is becoming a great disincentive for depositors to put their money in the bank.
This is the point when a time bomb starts ticking and that was how the infamous banking crisis hit Nepal’s financial system in 2009. The chain of reactions was very simple. In order to avoid negative interest rate and secure higher returns, depositors slowly lured towards highly risky speculative investments such as real estate and stock. Banks’ real estate lending and margin lending – lending against share certificate - increased by around 18 folds between 2006 and 2009. When the real estate and stock bubble burst in early 2010, putting at risk Rs 130 billion worth of bank investment, it shuck the very foundation of Nepal’ banking system. The blow to the banking system was severe that some of the banks are still trying hard to recuperate.
Against this backdrop, the continued negative interest rate is clearly an early warning that Nepal’s financial system is warming up for return to the baking crisis of 2010. As the amount of deposits continues to be higher than the lending, banks will continue to add up additional liquidity. In means, coming months will be more challenging in the sense that increased remittance will continue to swell money supply that will further increase rate of inflation and lower deposit rates along with the lending rates. The additional money supply during the Dashin festival might further worsen the situation.
The deadly combination of low deposit and lending rates along with the growing inflation will further provoke people toward risky speculative investments. Despite various restrictions enforced by the central bank to curtail real estate and stock lending, chances are high that both the sectors will see another bubble in coming months, albeit not in a scale seen before the 2010-banking crisis. And, chances are high that the cooperatives, which are in operation without strict regulatory policies and risk assessment mechanism, will be the inflator of the bubble. Despite some reputational issues, the cooperatives in recent times have been able to attract huge amount of deposits by offering deposit rate much higher than what the banks are offering. Though, Nepal badly lacks credible financial statistics on the finances of cooperatives, it is estimated that cooperatives have amassed huge deposits worth Rs 300 billion, one-fourth of deposits held by the banks. As the most of the banks are already close to the limit imposed by central banks on real-estate and stock lending, it is the cooperatives that will most likely emerge as the main real-estate lender after the upcoming festival, a pick season for land transactions. Undoubtedly, Nepal made wonderful efforts to consolidate regulations on the banking system and that produced appreciable results. By contrast, another slowly emerging player of the financial sector – cooperatives - remains in a sorry mess, mainly in terms of exercising financial prudency. No doubt, a major financial disaster is brewing there, but few people seem ready to pay due attention on the impeding risks.
Now the million-dollar question is: How to manage the swelling liquidity by preventing a possible huge flow of deposits from the banking system to cooperatives? One of the options available to deal with the excess liquidity is to lure additional investment to hydropower development by brining more investment friendly policies. It is because hydropower is probably the only sector that can absorb huge amount of liquidity with comparatively less risks, has a good prospect for both internal consumption and export, and has the potential to address the Nepal’s biggest impediment to growth. The recently announced policy to provide a lump-sum grant of Rs 5 million per megawatt is a right step in attracting investments to the hydropower sector.
However, unpredictable fluctuation in lending rates is still a discouraging factor. Many investors still recall the notorious rise in lending rate after the 2010-banking crisis. The rapid up to 5 percentage points rise in lending rate suddenly reversed the financial viability of the hydropower project. Such an unprecedented spike in lending rates badly tarnished investors’ confidence, compelling many to postpone the constructions activities. As one of the policy options to deal with such risks, the government should think of introducing a lending rate band - rate that can fluctuate between the upper and lower limits. The policy will help investors to predict the worst possible cost of lending and adjust returns and investments accordingly. The special refinance facility that the central bank has been administrating can be reformed to make such lending rate band workable.
Tuesday, August 26, 2014
Monday, December 10, 2012
Nepal's Experience With E-bidding
A major but incomplete reform
Nepal has witnessed grave incidents wasting a huge amount of scarce resources because of decade-old manual tender system for public procurement procedures. There have been many cases of unlawful alliances among suppliers and contractors, often in collusion with corrupt political leaders and bureaucrats, in the process of awarding public contracts.
News related to bloody violence, and even shootings, while attempting to prevent rival contractors from participating in bidding used to make headlines from August to November when the government used to invite bidders for civil construction projects worth billions of rupees. Hence, the decade-old manual tendering system with many loopholes to manipulate contract awarding system was the main source of corruption and irregularities. Not only that, such a huge misappropriation of state recourses in awarding contracts for public works was also the biggest challenge in promoting good governance and transparency in Nepal. Yet, things have optimistically changed lately, with the country, despite prolonged political uncertainty and stiff resistance from interest groups, implementing some massive reforms in the process of calling, evaluating and awarding tenders to rightful supplier or contractors.
Initiation of reforms
Public procurement process via manual bidding started in the 1960s when Nepal started its development endeavors. This traditional practice with many shortcomings and some serious loopholes – that allowed the bidders to form cartels and manipulate the whole contract-awarding system – became a mainstay for the next five decades. A bold step was taken in this regard in 2006 when the Public Procurement Act was enacted. This paved way for the establishment of the Public Procurement Management Office (PPMO) and the adoption of strict procedures for public procurements. But changes did not take place as rapidly as thought following a political upheaval in 2006. The revolution of that time did end the 250-year-old monarchy and established Nepal as the youngest republic, but at the same time intensified inter and intra-party feuds, weakening law enforcing agencies and resulting in a rapid deterioration of law and order situation in the country. This provided a breeding ground for growth of criminal gangs, which soon started maneuvering the public bidding process for public procurements that, on average, absorb half of the country’s annual budget.
Very soon, hiring of hooligans to secure contracts, incidents of intimidation and abduction of rival contractors started becoming a normal affair. Gradually, criminal gangs even started threatening local government officials, involved in evaluation of bid documents, sometimes forcing them to relocate their bases to the places where security arrangements were comparatively better. Then in 2008, Karan Singh Yadav of Biratnagar died in exchange of fire between criminal gangs. This not only dominated newspaper headlines but also exposed the scale of violence and criminalization associated with public bidding in the country. Soon after that, a shooting incident occurred in a tender-related dispute injuring several campus students in Kathmandu. Both these incidents sparked outrage across the country and created a strong public opinion for initiation of massive reforms in public procurement procedure. Then in 2008, the government introduced an experimental e-tendering system, initially for the road projects. The reform initiative, originally targeted at fending off criminal gangs, was another bold step in reforming the decade-old public procurement process in Nepal. Later, e-tendering became mandatory for public procurements worth more than Rs 20 million.
The impacts
Since the introduction of e-bidding system, there has been a remarkable decline in cases of violent incidents and a significant increase in the number of bidders. According to the DoR, of the total 2,764 e-tenders it has received, over 1,900 were received in 2011 alone. As the government has already adopted a policy of making e-tendering mandatory for public procurements worth more than Rs 20 million, the number of bidders using e-tenders for public contracts undoubtedly seems to rise in coming years. Moreover, the introduction of e-bidding has also helped in reducing the cost of development projects by up to 20 percent in some cases. The most striking figure came from the Ministry of Physical Planning and Works—the largest government agency handling the volume of development budget— saving more than Rs 3 billion out of the initially allocated budget for the purpose of various public contracts since the introduction of e-bidding four years back.
Moreover, it has solved over 80 percent of the problems that used to pop up during manual submission of tenders. This was because aspirant bidders didn’t have to hire criminal gangs or bribe officials to ensure that their bids reached the government office, which according to some estimates used as high as 10 percent of the quoted amount depending upon the nature of tender. In this context, a study conducted by Department of Roads on five major road projects revealed that the bid amount submitted by contractors through e-tendering was over 20 percent less than the initial estimate, while the procurement period needed to complete tender awarding processes became shorter by 20 days on average compared to up to 45 days in the past.
Way ahead
Even after four years of implementation of e-tendering system, Nepal still has not been able to adopt a fully automated tendering system that many developing countries have implemented. Undoubtedly, chronic power shortage and the lack of reliable Internet services have remained two major obstacles in this regard. However, the stern political resistance to reformation of the conventional procurement system has been the biggest problem. It was an open secret that manipulation of tender documents by yielding in to political influence and muscle power used to be one of the biggest sources of income for the politicians and bureaucrats, who are ironically often heard of reiterating their commitments to public procurement reforms. As actions speak louder than words, their dillydallying in putting necessary mechanism in place to ensure full-fledged operation of e-bidding system clearly reflects that they are merely paying lip-service to the much-crucial reforms that can keep a huge amount of development budget from sneaking into private banks accounts.
As a result, contractors are still required to submit hard copies of their bidding documents along with other related papers, as the existing system is only being used for submission of bids. Similarly, urgent calls for ensuring necessary tools and legal provisions that are needed to recognize digital certification and signatures of bidders have met with cold responses. Though the government has already endorsed the Electronic Transaction Act, it is yet to introduce some additional provisions to meet legal requirements on authentication of digital documents and signatures, something that has been another constraint in introducing full-fledged electronic bidding system. Additionally, the lack of online payment system to purchase tender documents has limited the scope of e-bidding in Nepal.
(The article was published in Republica)
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