As a student of economics, I enjoy connecting pieces of the puzzle to better understand complex economic phenomena. This time, I explore Nepal’s liquidity paradox from a macroeconomic perspective.
In the bustling tea shops and boardroom meetings of Kathmandu, a single question dominates the economic discourse: “If the banks have so much money, why is the economy so slow?”
Critics argue that the central bank’s policies are either too rigid or too reactive. However, a closer look at the macroeconomic math reveals that excess liquidity is not merely a "monetary" failure—it is a symptom of deep-seated structural imbalances across the entire economy. Liquidity mismatch in an economy is short-lived, but Nepal's liquidity mismatch is structural, protracted, and germinated from sectoral imbalances.
To understand why the NRB cannot simply "fix" this with a stroke of a pen, we must look at the fundamental identity that governs our national income.
The Unavoidable Identity
`S - I = \text{Current Account Balance}`
In macroeconomics, the "Liquidity Paradox" is explained by a simple equation:
`(S - I) + (T - G) = (R+ X - M)`
`(S - I)`: Private Savings minus Private Investment.
`(T - G)`: Government Tax Revenue minus Spending (Fiscal Balance).
`(R+X - M)`: Exports/Remittances minus Imports (Current Account Balance).
In Nepal today, this equation is heavily lopsided. Savings (`S`) are at an all-time high due to record-breaking remittances. Meanwhile, Investment (`I`) is shrinking because businesses are hesitant to expand. When the private sector saves more than it invests, that money flows into bank vaults.
Unless the government spends its budget (`G`) or the country starts importing capital goods (`M`), that money stays "trapped" as excess liquidity. The NRB manages the flow, but it doesn't create the structural dam holding the water back.
Breaking Down the Sectoral Imbalances
The reason we shouldn't "blame" the central bank alone is that liquidity is being forced into the system by three other powerful sectors:
The government often collects revenue efficiently but struggles to spend its development budget. When capital expenditure is delayed, the "multiplier effect" vanishes. Without government-led infrastructure projects, the private sector (cement, steel, construction) has no incentive to take out new loans. The NRB cannot force the government to build roads.
Even with interest rates at multi-year lows, credit demand is stagnant. Why? Because businesses are facing high operational costs and low consumer demand. When entrepreneurs choose to "wait and see" rather than build factories, the `S - I` gap widens. The central bank can make money cheap, but it cannot make it profitable for a cautious businessman. Share of private investment in GDP has declined to about 14 percent in 2025 compared to about 22 percent in 2021. This shortfall in private investment is the direct contributor of today's excess liquidity.
3. The External Sector: The Remittance Mirage (`R+ X - M`)
Nepal is currently experiencing a massive Current Account Surplus. We are receiving billions in remittances (`R`) but spending very little on productive imports (`M`). Every dollar sent by a migrant worker is converted into Nepalese Rupees by the NRB, injecting cash into the banks. If we don't use those dollars to buy machinery or raw materials, the Rupees simply pile up.
4. The Household Sector: Precautionary Savings
Amidst economic uncertainty, families are choosing to save rather than spend. This high level of "precautionary savings" further boosts bank deposits, contributing to the glut of loanable funds that no one is currently willing to borrow.
Reserve Adequacy: The "Golden Cage"
Foreign exchange reserves are currently enough to cover over 18 months of imports. While this provides security, it is also a mirror of domestic inactivity. High reserves occur because the country is not spending foreign earnings.
The Way Forward: A Multi-Sector Solution
A balanced approach is necessary. Excess liquidity cannot be solved by monetary tightening alone, nor should it be viewed as a technical failure of liquidity management. When savings persistently exceed investment, the solution must address the deeper structural drivers behind that imbalance.
In Nepal’s case, this requires coordinated reform across investment climate, fiscal execution, financial markets, institutional quality, and external management.
1. Improve the Investment Climate: From Saving to Investing
Nepal’s excess liquidity reflects cautious private behavior in an environment where regulatory uncertainty, slow contract enforcement, and weak property rights raise the perceived risk of long-term investment. Interest rates alone cannot overcome these structural constraints. Strengthening rule of law, ensuring consistent and transparent regulatory enforcement, improving dispute resolution, and securing collateral and land titling systems would reduce risk premiums and encourage firms to shift from defensive saving toward productive investment — the most organic way to absorb surplus liquidity.
2. Enhance Fiscal Effectiveness: Capital Expenditure as a Catalyst
Liquidity often accumulates when budgeted public spending, especially capital expenditure, is under-executed due to procurement delays and administrative bottlenecks. Front-loading high-quality infrastructure investment can stimulate private-sector borrowing, crowd in complementary investment, and strengthen aggregate demand. The solution is not simply larger deficits, but better execution — prioritizing productivity-enhancing sectors and improving public financial management so that fiscal policy supports structural transformation rather than short-term consumption.
3. Deepen Financial Markets: Channel Savings into Long-Term Capital
A bank-dominated financial system concentrates savings in short-term deposits, limiting their productive use. Developing government and corporate bond markets, strengthening pension and insurance funds, and expanding long-term financing instruments would create alternative channels to absorb excess deposits. Financial deepening transforms idle liquidity into infrastructure and industrial investment, reducing repeated reliance on central bank absorption tools and strengthening capital allocation efficiency.
4. Strengthen Institutions, Rule of Law, and Governance
Persistent liquidity surplus ultimately signals limited confidence in long-term economic prospects. Strong institutions — credible courts, transparent regulators, enforceable bankruptcy laws, and secure property rights — create predictability and reduce uncertainty. Strict but impartial enforcement of laws ensures that investment decisions are based on market fundamentals rather than discretionary practices, gradually shifting the economy from precautionary savings toward sustained capital formation.
5. Strengthen External Management: From Sterilization to Strategic Utilization
While sterilization operations can manage short-term liquidity pressures arising from remittance and foreign exchange inflows, they do not resolve structural imbalances between savings and investment. A strategic approach would use external strength to enhance domestic productivity — facilitating capital goods imports, encouraging technology adoption, and channeling remittances into investment vehicles. By expanding the economy’s absorption capacity, external inflows can become a driver of growth rather than a recurring source of excess liquidity.
Conclusion
Liquidity is a mirror that reflects the fundamental health of an economy's transformation engine. It tells us how effectively a nation turns its collective savings (remittances and deposits) into productive assets (factories, farms, and tech). Therefore, the current excess liquidity is a symptom of a confidence deficit. When banks feel protected by the Rule of Law and entrepreneurs are supported by Institutional Incentives, that idle cash will finally find its way into the factories, farms, and tech hubs that Nepal needs.
Blaming the central bank for protracted liquidity mismatch is actually superficial analysis. While the Nepal Rastra Bank can manage the supply of money, it cannot single-handedly create the demand for it. Nepal is persistently observing the episodes of excess liquidity and liquidity crunch and this mismatch germinates from sectoral imbalances. These imbalances are ignited by a myriad of factors: weak policy coordination between fiscal and monetary authorities, an erosion of business confidence, and institutions sans quality. When banks operate in an environment of lax enforcement, they inevitably retreat to land-based collateral, denying "idea-based" lending because the legal safety net is too thin.
The path forward is clear. When banks feel protected by a robust Rule of Law and entrepreneurs are energized by genuine Institutional Incentives, that idle cash will finally stop sitting in the vaults. Only then will Nepal's liquidity cease to be a "paradox" and start becoming the fuel that powers our national growth.
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