Kathmandu: A recent research study has revealed a troubling pattern in Nepal’s financial history, suggesting that every significant surge in bank lending—often referred to as a “credit boom”—has inevitably paved the way for an economic crisis. Analyzing the last 35 years since 1990, the study concludes that Nepal has experienced three major waves of excessive credit expansion, all of which resulted in severe negative repercussions for the national economy.
The research paper, titled “An Anatomy of Nepal Credit Boom 1990–2025” and authored by Birendra Bahadur Budha, the Acting Director of Nepal Rastra Bank, identifies the periods of 1994–1996, 2008–2010, and 2020–2022 as the three primary windows of rapid credit growth. These cycles saw a massive influx of capital into the market, but the long-term consequences proved to be detrimental rather than developmental.
According to the study, all three instances are classified as “bad booms.” Instead of stimulating sustainable economic growth, these periods of aggressive lending triggered economic slowdowns and sparked crises in the external sector. The findings suggest that the very mechanism intended to boost the economy ultimately became the catalyst for its instability.
The researcher argues that these excessive credit flows were primarily driven by financial sector reforms and prolonged periods of loose monetary policy. During these booms, banks and financial institutions tended to divert capital away from productive sectors, choosing instead to focus on real estate, the stock market, and personal consumption loans.
The study concludes that these three cycles followed a predictable pattern: they were born out of a relaxed monetary environment and concluded in external sector shocks. The most recent two booms were particularly intertwined with stock market volatility and a heavy reliance on bank financing for trading, which eventually led to a painful period of deleveraging as the credit bubble burst.
The consequences of these “bad booms” are reflected in widened current account deficits and a significant depletion of foreign exchange reserves. The macroeconomic performance following these surges has been consistently unsatisfactory. During the growth phase, sectors such as construction and the stock market witness high activity, but they are also the sectors that suffer the most catastrophic losses during the subsequent downturn.
There is a confirmed direct correlation between credit expansion and the fluctuations of the Nepal Stock Exchange (NEPSE). The study highlights that the market peaks—reaching 1,128 points in 2008 and an all-time high of 3,178 points in August 2021—coincided exactly with the heights of credit expansion. When the central bank was forced to tighten monetary policy to stabilize the economy, the stock market experienced a massive crash.
Applying international standards, the study defines a “bad boom” as a surge in credit followed by a recession or growth that remains below the long-term average. In Nepal’s case, productive sectors failed to show meaningful progress during these times, and the economy eventually contracted. The “output gap” became negative following the peaks of expansion, meaning the economy failed to produce at its full potential.
This phenomenon is evidenced by the fact that following the booms of 1997–1999, 2011–2013, and the projected period of 2023–2025, the average economic growth rate fell below the long-term average of 4.4 percent. This data reinforces the argument that unchecked lending creates a temporary illusion of prosperity while hollowing out the economy’s productive capacity.
The concentration of credit in non-tradable sectors like real estate and finance creates artificial wealth by inflating asset prices. While this makes the population feel wealthier in the short term, it significantly increases systemic financial risk. The research notes that the historical highs of the NEPSE index in both 2008 and 2021 were fueled by the extreme limits of credit expansion rather than fundamental economic strength.
Consequently, when Nepal Rastra Bank intervened to control credit through tighter monetary policies, the stock market plummeted, leaving investors with massive losses. This cycle of boom and bust has consistently harmed the financial health of the public and the stability of the banking system.
Furthermore, every credit boom has put immense pressure on Nepal’s foreign exchange reserves and the balance of payments. Because the Nepali Rupee is pegged to the Indian Rupee, excessive local credit expansion translates directly into a surge in imports. When credit is easily available, consumption of luxury goods and vehicles increases, which rapidly drains the country’s dollar reserves.
The historical data is stark: in 1996, the current account deficit reached 8.7 percent of the GDP, and during the most recent boom in 2022, it skyrocketed to approximately 12.5 percent. This imbalance eventually forces the central bank into a corner, necessitating drastic measures such as import bans and high-interest rates to prevent a total collapse of foreign reserves.
The study also takes a close look at the post-COVID recovery phase, noting that from August 2020 to March 2022, Nepal adopted an exceptionally loose monetary stance. For a significant period, interbank interest rates remained below 1 percent, which, combined with flexible credit policies, accelerated the most recent credit surge.
At the height of this period in February 2022, the refinancing facility provided to businesses reached over 158 billion rupees. While intended to provide relief to pandemic-affected industries, the study supports the suspicion that much of this liquidity bypassed the intended victims and instead flowed into real estate and the stock market.
To prevent future instability, the research suggests that Nepal must cap its credit expansion. It concludes that any rapid growth exceeding 10 percent of the GDP is a danger zone for an economy like Nepal’s. Crossing this threshold consistently leads to unsustainable current account deficits and places the external sector under unbearable pressure.
Given the fixed exchange rate system, the study emphasizes that the timing of policy intervention is critical. Because Nepal’s previous credit booms have proven to be “bad” by nature, it is essential to implement monetary and macro-prudential measures at the earliest signs of overheating to address the external sector risk.
In its final analysis, the research underscores that the effectiveness of these monetary and macro-prudential tools depends heavily on policy coordination between various government agencies. Without synchronized action, Nepal remains vulnerable to the recurring cycle of credit-driven artificial growth followed by inevitable economic distress.
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