In a major blow to Nepali busi­nesses, banks and financial insti­tutions (BFIs) have again started raising interest rates on their loans, even as they were expected to gradually bring them down. They had started increasing their lend­ing rates after Nepal Rastra Bank (NRB), the central bank, increased their paid-up capital requirements last year. As cost of production has gone up due to high lending rates, the com­petitiveness of our industries has gone down. Even before the recent rate hike, Nepal was considered a high cost-of-production destination, with its high transport costs, lack of reliable electricity, labor unrest, and frequent strikes.

Shekhar Golchha, vice presi­dent of the Federation of Nepalese Chambers of Commerce and Indus­try, blames the NRB of failing to effectively regulate BFIs in order to maintain stable lending rates. Such regulation is crucial to maintain the predictability that is required to run any business, he says.

Higher lending rates also affect FDI inflow, as foreign investors increasingly worry about the health of Nepali economy. According to the NRB, FDI inflow is down 40 percent in first five months of this fiscal (Rs 6.78 billion) compared to the same period (Rs 11.12 billion) the previous fiscal. Along with foreign investment, domestic investment has dried up as well.

Investors fear their projects will be unviable. The multi-year projects designed and started on assumption of one set of borrowing rates are suddenly having to pay double the agreed rates. For instance, hydro­power projects, which have fixed rate of return and which cannot pass on increased cost to consumers, are badly affected.

BFIs’ rampant expansion of loans has increased default rates as well. As the rates continue to climb, most of those who brought out auto or home loans are not in a position to repay. This is dangerous. As the volume of non-performing loans increase, not only the profits of banks will be affected. It will imperil the whole financial sector.

Moreover, consumer prices will shoot up when producers and trad­ers have to pay higher interests on their borrowings. They will simply pass on loan servicing cost to their final consumers. In Nepal, where a large chunk of the credit goes to import financing, higher rates will make imports dearer.

At the root of the problem is that banks are lending beyond their capacity. They are giving more than they are collecting. In the first six months of this fis­cal commercial banks’ deposits increased by Rs 168 billion (up 7 percent) while their loan mobili­zation increased by Rs 245 billion (up 12 percent).

Interest payment is the major source of earning for the BFIs. How­ever, they should refrain from biting more than they can chew. The bur­geoning defaults could ultimately sink them.