One-and-a-half years ago, BhimLalPoudel, theowner of Royal Shoe, rapidly expanded business operation, raising the factory’sstaff strength by around 50 per cent to 225. A critical factor that encouragedPoudel to increase production of shoes was low interest rate on loans.

“Lending rate had fallen to seven per cent per annum. Thishad drastically reduced my debt servicing cost, enabling me to expand thebusiness,” says Poudel, who had acquired around Rs 80 million in credit from acommercial bank some six years ago to set up his shoe factory.

Ironically, the interest rate which had once worked as anincentive for Poudel has now emerged as a disincentive threatening his veryexistence. This is because the interest on Poudel’s loan has spiralled up fromseven per cent to 13 per cent. “I’m now forced to pay Rs 4-5 million extra peryear in interest cost,” says Poudel. “This high debt servicing cost is noweating into my profit.”

Poudel has since cut around 75 jobs to make up for theloss. “I’ll have to cut more jobs if bank financing continues to becomeexpensive,” says Poudel.

Commercial banks have been raising lending rates for thelast several months, stating deposits have become expensive due to decelerationin remittance inflow and slow public spending, especially capital spending.This has pushed up lending rates to as high as 22 per cent.

“The capital has become very expensive these days, makingit tough for businesses to survive,” says Sunil Chitrakar, vice-president ofthe Federation of Handicraft Associations of Nepal.

The central bank has informally said that it intends tokeep deposit rates within a range of seven to eight per cent and lending rateswithin a range of 12 to 13 per cent this fiscal. Nepal Bankers’ Association hasalready barred commercial banks from offering over eight per cent interest onsavings deposits and over 11 per cent interest on fixed deposits. The centralbank has given tacit approval to this practice of locking the deposit rates, which,many say, thwarts competition. But it has maintained awkward silence aboutrunaway lending rates. This is hurting the productive sector, which needs largechunks of capital to keep their businesses moving.

“Interest rate on term and working capital loans has nowbreached the 13 per cent mark and is likely to hit 15 per cent soon,” saysRabin Kumar Shrestha, president of the Footwear Manufacturers Association ofNepal. These rates, according to many, are being raised even without givingprior information to borrowers. “How can entrepreneurs of the productive sectorsurvive in this environment?” questions Shrestha.

The government and the central bank have long been sayingmore credit should go towards the productive sector to raise domesticproduction, create jobs, bridge the ever-widening trade deficit and stimulateeconomic growth. A big portion of banking sector loans is being used topurchase real estate, stocks and cars, considered unproductive areas, as theycannot create jobs continuously.

Nepal needs to create more jobs in the coming days becausefewer workers are going abroad for employment.

Around 512,000 workers join the domestic job market everyyear, according to the Ministry of Finance. Earlier, over 400,000 of these newentrants used to find jobs in overseas labour markets. Now the outflow ofNepali workers has declined, meaning more jobs need to be created in thecountry. This calls for the need to establish more small and mediumenterprises, as they are the biggest job providers in many countries.

“But how can new enterprises be established when the costof capital is so high and all the profit is taken away by banks?” asksChitrakar, implying it is safe to bet on real estate and stocks where returnsare high.

Unlike other sectors, banks have been making handsomeprofits year after year. The combined net profit of 28 commercial banks jumped15.5 per cent to Rs 36.3 billion in the third quarter of this fiscal, accordingto unaudited financial reports of these financial institutions.

One of the reasons for uninterrupted profit year after yearis the central bank’s provision, which allows banks and financial institutionsto maintain interest spread of five per cent. This means a bank which hasbought deposit at an interest of 11 per cent per annum can sell it in the formof loan at an interest of up to 16 per cent.

The Federation of Nepalese Chambers of Commerce andIndustry, the largest private sector body, had earlier called for reduction ininterest spread. But nothing has been done. Worse, commercial banks have beenbreaching the regulatory limit on interest spread since November, central bankreport shows. But no action has been taken. All the while, firms that churn outshoes, handicraft items and other goods and services are seeing their profitsshrink.

If the government is to entrench a revolution in theproductive sector, this problem ought to be addressed. But nothing is likely tohappen anytime soon.

Lending rates are likely to remain high for the time being,as Rs 15-16 billion is expected to exit the banking system as early as thisweek in the form of advance payment for two wide-body aircraft that NepalAirlines Corporation is purchasing. “This will exert pressure on liquidity ofsome banks, making it harder to reduce lending rates,” Sanima Bank CEO BhuvanKumar Dahal said. “But the government’s capital expenditure is expected to goup from mid-May, which will enable banks to lower the rates.”

Nonetheless, lending rates are unlikely to fall to therange of one-and-a-half years ago, as banks are likely to say their cost offund has gone up because they have been purchasing deposit at high rates. Thiswill knock the confidence of investors and prevent them from establishing newbusinesses or expanding existing ones.

“The central bank is not planning to make any interventionfor the time being to bring down the lending rates,” a senior central bankofficial said on condition of anonymity. Central bank spokesperson NarayanPrasad Paudel could not be contacted.

Source: The Himalayan Times, 2^nd April 2018