I

KATHMANDU UNIVERSITY SCHOOL OF MANAGEMENT

Balkumari, Lalitpur

Macroeconomics Term Paper on:

IMPACT OF RECENT MONETARY POLICIES ON REAL ESTATE OF

NEPAL

Submitted to: Submitted by:

Mr. Binayak Chhetri Aabhash Shrestha
Faculty of Macroeconomics Roll No: 177095
Section: B
BBA Hons: Semester: II Year I

Date: May 20, 2018

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ACKNOWLEDGEMENT

First and foremost, I would want to express my sincere gratitude to Kathmandu

University School of Management (KUSOM) for providing me this platform to enhance my

interpersonal skills, mass communication skills, research ideas, and primary ways of data

collection and analysis. This assignment has made me realize about the importance of practical

learning.

I am grateful to Mr. Binayak Chhetri for providing us this ample opportunity of

exploring through the various topics of macro-economic issues that has been a new journey into

understanding the practicability of economics in our day to day lives. I acknowledge with thanks

to Mr. Binayak Chhetri for his kind patronage , timely guidance and a continuous effort to push

us forwards , not only being confined within the pages of books, but into understanding the

various aspects of economics in real world.

I would also want to express my sincere gratitude to the members of library of

Kathmandu University School of Management (KUSOM) for providing me assistance in

searching various books related to my project.

Besides, I would also want to thank Mr. Tulsi Prasad Adhikari and Mr. Hari

Narayan Shrestha, who have been in working in real estate of Nepal for the last decade, for

providing me insights on various aspects of real estate of Nepal.

Last but not the least, I acknowledge with thanks to my family members and

friends for their assistance in any ways possible.

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TABLE OF CONTENTS

List of Figures ............................................................................................................................... IV

Abstract ...........................................................................................................................................V

Introduction ......................................................................................................................................1

Liquidity Crunch And Aggressive Lending On Real Estate ...........................................................4

Discouragement of Real Estate ........................................................................................................6

Changes in Monetary Policies and its Impact on Real Estate .........................................................9

Conclusion .....................................................................................................................................14

Suggestions ....................................................................................................................................16

References ......................................................................................................................................17
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LIST OF FIGURES

Figure 1: GDP calculation ...............................................................................................................7

Figure 2: Money supply and money demand .................................................................................10

Figure 3: Interest rate and Investment on real estate ....................................................................12

Figure 4: Declining revenue from real estate .................................................................................13

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ABSTRACT

This term paper looks into the present scenario of real estate in Nepal. With the

recent changes in monetary policies, we can hear in the news as well as in the market, regarding

the decrease in the demand of real estate. This term paper looks into the various changes in the

monetary policies of 2017/18 and analyzes its impact on real estate of Nepal based on four sub

headings: introduction, liquidity crunch and aggressive lending on real estate, discouragement of

real estate, changes in monetary policies and its impact on real estate and conclusion.
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INTRODUCTION

In recent months, the demand for real estate, especially in and around the areas of

Kathmandu valley has seen a heavy decline. With recent announcements made by government

and Nepal Rastra Bank officials to channelize the money from non-productive sectors such as

real estate and stock market into productive sectors such as agriculture and industry, not only the

prices but also the demand of real estate has taken a down turn in Nepalese economy. This paper

analyzes the various aspects of recent changes in monetary policies and the impact it has made

on the real estate industry of Nepal.

Productive sectors refer to those activities that contribute to the Gross Domestic

Product (GDP) of a nation. There is exchange of money along with the creation of some goods or

services. Example of productive sector would be agriculture. On the other hand, non-productive

sectors refer to those activities that do not contribute to the Gross Domestic Product of a nation.

These activities usually include capital gains or financial claims that are not included in the GDP

of a nation. Real estate is regarded as one of non-productive sectors in a nation’s economy.

However it is to be noted that construction of residential buildings is calculated in a country’s

GDP, but selling and purchase of these residential buildings are not included in that year’s GDP.

Monetary policy refers to the actions taken by central bank, currency board or

other regulatory committee to determine the size and rate of growth of the money supply in a

nation, which ultimately affects the interest rate. Monetary policies are used in order to fulfill

certain macroeconomic objectives policy such as growth, employment, price stability and

balance of payment equilibrium. The recent monetary policy of Nepal focuses heavily to uplift

productive sectors such as agriculture and hydro power and discourages people from investing in
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nonproductive sectors such as real estate, basically to prevent the over valuation of real estate on

one hand and to increase employment and GDP of the country in the long run.

The instrument of monetary policy are tools or devices which are used by the

monetary authority in order to attain some predetermined objectives. These tools are usually

categorized into quantitative and qualitative tools. Previously Nepal Rastra Bank followed

monetary instruments such as interest rate, margin rate and statutory liquidity ratios (SLR).

However nowadays, instruments such as cash reserve ratio, open market operation and bank rate

have been used.

The margin rate refers to the proportion of the loan amount which is not financed

by the bank. This method is used to encourage credit supply for the needy sector and discourage

it for other non-productive sectors. This can be done by increasing margin for the non-

productive sectors and by reducing it for other needy sectors.

The open market operation refers to the purchase and/or sale of short term and

long term securities by the Nepal Rastra Bank in the open market. If Nepal Rastra Bank sells

securities in an open market, commercial banks and private individuals buy it. This reduces the

existing money supply as money gets transferred from commercial banks to Nepal Rastra Bank.

Contrary to this when the Nepal Rastra Bank buys the securities from commercial banks in the

open market, commercial banks sell it and get back the money they had invested in them.

Every bank is required to maintain a fixed percentage of its assets in the form of

cash or liquid assets which may be excess reserves, securities, current account with other banks,

referred to as statutory liquidity ratios (SLR). An increase in the SLR reduces the bank’s liquid

assets and thus reduces their ability to give credit. A decrease in SLR has the opposite effect.
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Cash Reserve Ratio (CRR) refers to the minimum percentage of a bank’s total

deposits required to be kept with the central bank. An increase in the CRR has the effect of

reducing the bank’s excess reserves and thus reduces their ability to give credit. On the other

hand, a decrease in the CRR has the effect of increasing the bank’s excess reserves and thus

reduces their ability to give credit.

Nepal Rastra Bank has made effective use of all these instruments collectively in

order to reduce the money supply on non-productive sectors such as real estate, reducing its

demand. Besides Nepal Rastra Bank has also directed all the commercial banks to increase and at

least have the loan portfolio towards the productive sectors to 20 percent.
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LIQUIDITY CRUNCH AND AGGRESSIVE LENDING ON REAL

ESTATE

Liquidity crunch refers to the time phase when the demand of money is high and

its supply is relatively low than its demand. The banking sector has been suffering a liquidity

crunch for months and the amount it can give to its customers is declining. As per Nepal Rastra

Bank, banking and financial institutions can lend only 80 per cent of sum of core capital and

deposit (CCD) ratio. As per Nepal Rastra Bank however, the CCD ratio of most of the

commercial banks has exceeded the limit of 80 percent. The CCD ratio is calculated by dividing

total loan granted sin local currency by the sum of deposits, equity capital and portion of net

income retained by institutions, which is then multiplied by 100.

There are various factors that are decreasing the loanable funds of the

commercial banks. First and foremost, in recent times, the flow of remittance money has

decreased. At the same time, the number of outbound Nepali migrant workers is declining and

one of the major labor destination country - Qatar is in uncertainty of sustaining further workers

from Nepal. The Nepal Rastra Bank data shows that the country received a total of Rs.566.97

billion in remittance in the first 10 months of this fiscal year, compared to that of Rs.538.87

billion in the corresponding period of previous fiscal year, indicating a drop of about 5.22%.

Thus the amount that banks can loan is decreasing too.

Although commercial banks have tried to cope up this liquidity crunch by trying

to increase its deposit amount through hike in its interest rates, but it has not been the case so. In

the recent months, the interest rates have hiked up to 12% on fixed accounts while it remains 7%
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to 8% on saving deposit accounts on average, yet the commercial banks report on having to face

liquidity crunch.

As the commercial banks are being under pressure to hike their paid-up capital to

Rs.8 billion, they are trying to raise their capital. Again to satisfy the expectations of getting

bonuses of the shareholders due to the raise in capital, the commercial banks have directed a

large portion of their loan portfolio towards real estate.

In my interview with Hari Narayan Shrestha, who has been working on purchase

and re selling of lands in and around the area of Bhaktapur, had his opinion that getting loan

from commercial banks had never been that easy before.

Ashok SJB Rana, CEO Himalayan Bank said to the media that, "The NRB lacks

clear policies to ease the credit crunch. It just blames us for the crisis saying we are lending to

unproductive sectors. There has to be coordination between the NRB and us."

The Nepal Rastra Bank is concerned about the flow of credit to the unproductive

sector as it clearly mentions on the Monetary Policy 2017/18 published on its site as,

“The monetary policy also aims at maintaining stability in the foreign sector,

boosting the productive sector by directing more and more loans to this sector, increasing

financial access and promoting financial literacy”

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DISCOURAGEMENT OF REAL ESTATE

The Nepalese economy had been facing all-time high boom on real estate until

recently when KP Oli led government appointed Dr. Yubraj Khatiwada as the Finance Minister,

which as per many economists was the right decision as he in 2010, being the governor of Nepal

Rastra Bank, had prevented the so then real estate bubble from bursting. Recently, the actions

taken by Nepal Rastra Bank in guidance with the country’s fiscal policy to control real estate, are

impressive.

A real estate bubble refers to increase in real estate prices usually due to increase

in demand or speculation. Real estate bubbles usually start with an increase in demand and with

limited supply, real estate starts to become overvalued. Speculators and real estate brokers

further hike up the demand, leading real estate to be more overvalued. At some point however,

this demand will decrease and along with increase in supply at the same time, results in a sharp

drop in prices of real estate referred to as real estate bubble burst.

Real estate bubble burst was also about to happen in 2010. Dr. Yubraj Khatiwada

was the Governor of Nepal Rastra Bank when Nepal’s real estate market was witnessing the

biggest boom ever. Commercial banks had about 60 percent of their loan portfolio directed

towards real estate, with real estate being both attractive and yielding immediate and alluring

results. The country’s real estate was needlessly hiking up, until December 2009 when

everything changed with Dr. Yubraj Khatiwada’s policies to control the real estate bubble. The

interest rate offered in saving accounts at that time was about 6.5% and the nation hadn’t been

going through current magnitude of liquidity crunch. The trade deficit has hit an all-time high,

and remittance is declining while the budget deficit has hit Rs.78 billion.
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Years Agriculture Real Estate Total GDP

(in millions Nrs) (in millions Nrs) (in millions Nrs)

2011/12 224703 50346 670279

2012/13 227193 52960 697954

2013/14 237521 54889 739754

2014/15 240137 55313 764335

2015/16 240205 57373 767491

2016/17 252901 60398 825048

Figure 1: GDP Caclulation

300000

250000

200000

150000

100000

50000

0
2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

Agriculture Real Estate

With above data taken from Monetary Policy Report 2017/18, we can see that

Agriculture has a major contribution in the GDP of Nepal. Out of total GDP of Rs.825,048.9

million of 2017/18, agriculture alone contributed Rs.240,205.9 million (about 29.11%) while real

estate contributed about Rs.60,398.8 million (about 7.3%).

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However, in the year 2011/12, the percentage of contribution of agriculture and

real estate on total GDP of Nepal was about 33.53% and 7.5% respectively. It is to be noted that

2011/12 was the time period when government as well as Nepal Rastra Bank had highly

demotivated real estate and other unproductive sectors. Thus, it shows us that there has been a

heavy decline in the GDP contribution from agriculture sector, dropping down from 33.53% to

about 29.11% in a span of 5 years while the real estate’s contribution has been fairly stable.

Declining agriculture as well as other productive sectors, with the rise of

unproductive sectors such as real estate is the major reason why Nepal Rastra Bank has tried to

discourage investment in real estate sector.

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CHANGES IN MONETARY POLICIES AND ITS IMPACT ON REAL

ESTATE

Through Monetary Policy Report 2017/18, it becomes very clear that Nepal

Rastra Bank is using its monetary tools to promote agriculture on one hand while discourage

investments on real estate on the other hand, while tackling the problem of liquidity crunch.

First and foremost, Nepal Rastra Bank has been discouraging investment on real

estate sector. Banks and financial institutions were required to reduce their real estate lending to

25 percent of the total lending and to 40 percent in both the real estate and housing by the

December of 2016. On the other hand, the commercial banks were directed to keep at least 20

percent of their loan portfolio guided towards various productive sectors.

Secondly, Nepal Rastra Bank has been trying to inject money in the market in

order to end the liquidity crunch. Nepal Rastra Bank has injected total liquidity of Rs.546.29

billion from mid July 2016 to 6 July 2017. The liquidity injection consists of various instruments

of open market operation, changing reserve ratios and purchase and sale of foreign currency.

Altogether Rs.61 billion liquidity was injected through Open Market Operations during mid July

2016 to 6 July 2017. The Nepal Rastra Bank also injected net liquidity of Rs.422.90 billion

through the net purchase of USD 3.98 billion from commercial banks from mid-July 2016 to 6

July 2017. This shows that the monetary policy of Nepal has been increasing the money supply

in the nation.

A figurative comparison of the money market of Nepal with year 2011/12 and

2016/17 has been done as follows:

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Years Interest Rates National income

(in percentage) (in million Nrs)

2011/12 6.5 1,539,635

2016/17 7 2,627,019

Figure 2: Money demand and money supply

MS 1 MS 2
i LM 1
i LM 2

B
7%
MD2 A’ B’
A
6.5%
MD1
2281430
1539635

O M/P O Y
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In the given figure, we can see that at first there is rightward shift in money

supply curve (from MS1 to MS2) due to injection of money through various means by Nepal

Rastra Bank as discussed in the preceding part of the paper. As we are taking a period of 5 years,

we can see that the interest rates have risen from 6.5% to about 7%, which only can be due to the

right ward shift in money demand curve (from MD1 to MD2) creating new equilibrium at point

B. This along with the evidences of increase in National Income from Rs.1,539,635 million to

Rs.2,627,019, indicated a rightward shift in the LM curve.

The government’s approach to control the investment on real estate through the

use of various monetary policies seem to have work quite remarkably. Injection of money in the

market to hike up the interest rates, has also had its impact on real estate of Nepal.

Years 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18

Interest 6.5 7 8 8 8 7 7 to 8

rate (in %)

With the above data of interest rates over a span of 7 years, we can see in the year

2017/18, the interest rate has taken a hike from 7% to about 7% to 8%. This theoretically

suggests us that along with the increase in interest rates, there must be a decline in the investment

for real estate. The data taken from Department of Land Reform and Management, suggests us

that it is indeed happening in and around the Kathmandu valley.

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Investment
Figure 3:
Interest rate

I1

8%
I2
D
7%

O O National Income
I2 I1
Investment

As the interest rates rose from 7% to 8% in the year 2017/18, the cost of

investment rose, leading into a drop in investment from I1 to I2.

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Months Kathmandu Bhaktapur Lalitpur

Dec-16 103

Jan-17 69.86 12.93 14.94

Feb-17 10.62 11.98

Figure 4: Declining Revenue

120

100

80

60

40

20

0
Kathmandu Bhaktapur Lalitpur

Dec-16 Jan-17 Feb-17

Among the eight land revenue offices inside the Valley, the data suggests that

since December 2016, the revenue collections of all the Department of Land Reform and

Management offices has reduced by 40 per cent on average. In December, seven land revenue

offices had collected Rs 103 crores as custom registration inside the valley. However, in the

month of January, it went down to Rs 69.86 crores. Similarly, the collections of Department of

Land Reform and Management offices in Bhaktapur and Lalitpur has also seen a sharp down

turn. This shows that investment on real estate, in and around Kathmandu valley has sharply

declined, with the changes in monetary policies of Nepal Rastra Bank.

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CONCLUSION

Despite a heavy decline seen in the real estate sector of in and around the

city areas of Nepal, the investment in real estate sector in dormitory towns and under

developed areas is increasing . Besides, the rate at which land and houses are being registered

along with the design approval of permanent buildings have seemed to slow down.

As per the data, the government collected Rs.19.29 billion revenue from

land and house registration tax in the last fiscal year 2016-17, which was 39.8 per cent

higher than the figure of the previous fiscal, while the revenue collection in city areas is

declining as analyzed in the above sections of this paper.

Fiscal Year Land and house Design approval of Land and house

registration permanent buildings registration revenue

(in billion Nrs)

2014/15 715,190 26673 9.84

2015/16 749,310 39627 13.79

2016/17 816,789 52476 19.29

As per the data provided by the central bank, approval of house designs

has decreased in Kathmandu, Pokhara and Dhangadi by 3.3 per cent, 9.9 per cent and

18.2 per cent, respectively. However, it has increased by 28.6 per cent in Biratnagar, 15

per cent in Janakpur, 7.9 per cent in Birgunj and 26.9 per cent in Nepalgunj area.
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This indicates that the monetary policies to control investment on real estate in

and around Kathmandu valley has been successful yet it has not been that effective in other parts

of the country.

Tulsi Prasad Adhikari and his partner Hari Narayan Shrestha, who have been

working in the field for real estate for about a decade, had their opinion that it is basically

because the government has controlled plotting in and around the Kathmandu valley. They told

that they themselves had their land in Bhaktapur, stuck because of town planning and had their

reasoning that it is due to federalism because of which the demand for real estate around

Janakpur, Biratnagar and Pokhara is increasing.

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SUGGESTIONS

The Nepal Rastra Bank has introduced effective monetary policies to prevent the

real estate bubble from bursting. However real estate is one of the basic preliminaries of human

life and with the increasing population of Nepal at the estimated growth rate of 1.16% (as per

2017), it is to be noted that the investment on real estate would be ever expanding. It is the

control on over valuation of real estate that should be the major focus of the monetary policies.

The Nepal Rastra Bank has guided banking and financial institutions to cut short

their loan portfolio directed towards real estate to 25 percent of the total loan, while the loan

portfolio towards productive sectors must be at least 20 percent of the total loan. This directed

loan portfolio towards real estate, is still much high and a few percent cut off may be made to

prioritize other sectors such as energy and tourism, through selective credit control and through

moral suasion.
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REFERENCES

 Monetary Policy for 2017/2018:

https://www.nrb.org.np/ofg/monetary_policy/Monetary_Policy_(in_English)--2017-
18_(Full_Text)-new.pdf

 Nepal Rastra Bank, Economic Analysis Division Research Department, July 2011:

A report on Real Estate Financing in Nepal - A case study of Kathmandu Valley

 Hari Prasad Shrestha, Time of Crsis, Ekantipur, March 30,2018:

http://kathmandupost.ekantipur.com/news/2018-03-30/time-of-crisis.html

 Sagar Ghimire, NRB shrugs off liquidity crunch, My Republica, January 10, 2017:

http://www.myrepublica.com/news/12807/

 Uttam Maharjan, Liquidity Crunch, The Rising Nepal:

http://therisingnepal.org.np/news/17520

 Liquidity crisis hits real estate hard, The Himalayan Times, April 1,2017:

https://thehimalayantimes.com/business/liquidity-crisis-hits-real-estate-hard/

 Ramesh Kumar/Sikuma Rai,Crunching members on credit, Nepali Times, March 8,2018:

https://www.nepalitimes.com/here-now/crunching-the-numbers-on-credit/

 Interview with Dr. Yubraj Khatiwada, New Business Age :

http://www.newbusinessage.com/Articles/view/199

 Ramesh Kumar/Om Astha Rai, Yubraj Khatiwadas turn, Nepali times, February 26,2018:

http://archive.nepalitimes.com/blogs/thebrief/2018/02/26/yuba-raj-khatiwadas-turn/

 When Did Real Estate Bubble Burst,Investopedia, February 7,2017:

https://www.investopedia.com/ask/answers/100314/when-did-real-estate-bubble-
burst.asp