The paper examines the interest rate pass through of the policy interest rate to the market interest rate in Nepal. The span of the empirical exercise covers the phase of interest rate liberalization commencing from the first quarter of 1989/1990 to the final quarter of 2008/2009. The result suggests that there is a significant long run elasticity coefficient of the policy rate (taken to be the bank rate) to the different market rates (e.g. 1 yr fixed deposit, lending rate and saving rate), but there is only one error correcting relationship between the bank rate and the lending rate in the short run. However, the speed of adjustment, i.e. the adaptation coefficient, indicates a weaker adjustment of the short-term dynamics to the long run equilibrium. Looking at the sub-sample, which coincides with the promulgation of the NRB Act 2002, the period starting from the third quarter of 2001/2002 to the final quarter of 2008/2009, suggests that there is insignificant elasticity coefficient between the policy rate and two of the above-mentioned market rates. Paradoxically, while the elasticity coefficient between the policy rate and lending rate is found to be significant, it is negative! Overall, the situation indicates that at present, the bank rate in Nepal is ineffective in influencing the market rates and suggests that there are other factors at play. The paper ends by recommending introduction of a more effective indicator of monetary stance, greater awareness of external factors when making monetary policy, and enhancing and guiding the development of the domestic financial sector for equitable financial development and growth.

FDI is much sought after in conflict-stricken countries such as Nepal as it can play a crucial role in the development process. However, the process of attracting and promoting FDI is complex, in particular as most developing countries, including Nepal, are competing for similar types of FDI. Although a number of efforts have been made in the past to boost FDI flows to the country, they have not had any striking impact. The country has not been able to draw on the potential technological and other contributions that FDI can make to the process of development. This underlines the need for effective policy interventions with a view to maximizing the benefits of FDI for Nepal’s development in an open environment. Nepal also needs policy framework to enhance national and regional infrastructure, in areas such as transport, energy and communications services, and to generate domestic employment and skills transfer. The main policy conclusion that can be drawn from this paper is that the economic benefits of FDI are real, but they do not accrue automatically. To reap the maximum benefits, a healthy enabling environment for business is paramount, which encourages domestic as well as foreign investment, provides incentives for innovation and improvements of skills and contributes to a competitive investment climate

The potential output and output gap are key variables in identifying the scope for sustainable non-inflationary growth and assessment of the stance of macroeconomic policies. This paper estimates potential output and the output gap in Nepal by different methodologies. The different methodologies produce similar results followed by analysis and observations. The results show that the output gaps were within relatively narrower band since 1990s. The results also reveal some sign of overheating in recent years. The results from production function approach indicate that total factor productivity is declining continuously in the last decade limiting the scope for demand management policies to attain high and sustainable economic growth.

This paper empirically examines the welfare losses arising from the currently rising inflation rate of Nepal using the method introduced into the literature by Bailey (1956) and the demand for real balance function put forward by Deaver (1970). Utilizing annual time series ranging from 1973 to 2009, the result obtained here supports the theoretical underpinning that the rise in inflation is leading to decrease in real balance and hence increase in welfare loss. It is also found that the rate of increases in welfare cost as a result of significant rises in inflation is sluggish. Further, the finding also leads one to conclude that the significant fraction of real income as welfare cost in the year 2010 corresponds to other factors affecting real balance rather than anticipated inflation. However, the evidence is consistent with the view that such cost may change under the relaxation of restrictions imposed corresponding to government’s motivation in raising inflation tax revenue (seigniorage), investment decisions of the economic agents, inflation uncertainty affecting the behavior of money holders and optimal rate of inflation specified.