Nepal’s central bank study reveals three credit booms over three decades consistently triggered busts, exposing the risks of unsustainable lending and urging tighter policy coordination for stable growth.

A new study by Nepal Rastra Bank (NRB) has laid bare a troubling pattern in the Himalayan nation’s economic history: over the past three decades, three major credit booms have each ended in painful downturns, leaving the economy scarred by widened deficits, depleted reserves, and sluggish growth.

Titled An Anatomy of Nepal’s Credit Boom 1990–2025, the working paper by acting director Birendra Bahadur Budha identifies lending surges in 1994-96, 2008-10, and 2020-22 as classic examples of “bad” credit booms – periods where rapid loan expansion outpaced real economic output, fuelling speculation rather than productive investment.

The anatomy of a credit boom

Economists define a credit boom as a period when credit-to-GDP growth exceeds a 20 per cent threshold, often driven by loose monetary policy, financial liberalisation, and fiscal expansion. In Nepal’s case, all three episodes funnelled credit disproportionately into real estate, imports, and stock market speculation, with minimal spillover into manufacturing or other productive sectors.

Experts like former National Planning Commission vice-chairman Prakash Kumar Shrestha note that while credit growth is vital for development, Nepal’s booms overheated the economy without building lasting capacity. “The credit did not go to manufacturing, leading to a minimal contribution to GDP,” Shrestha observed.

Santosh Koirala, president of the Nepal Bankers’ Association, echoed concerns about misallocation, particularly after the COVID-19 pandemic, where funds flowed into speculative assets rather than industry.

First boom: Post-democracy liberalization (1994-96)

Nepal’s first major credit boom coincided with the euphoria following the 1990 People’s Movement and the shift to multi-party democracy. Sweeping economic liberalization – including the Companies Act, establishment of the Nepal Stock Exchange, and opening to foreign investment – spurred a proliferation of banks and finance companies.

From just seven institutions in 1991, the number ballooned to 55 by 1996. The central bank cut interest rates sharply, flooding the system with cheap liquidity. Credit growth hit 40.5 per cent in 1994 and 42.1 per cent in 1995, with credit-to-GDP gaps surging. GDP growth, however, peaked at 8.22 per cent before tumbling to 3.47 per cent in 1995.

The bust was swift: credit slowed dramatically, imports and exports contracted, the current account deficit widened to 8.7 per cent of GDP, and balance of payments slipped into deficit. Foreign exchange reserves fell from covering 7.9 to 5.4 months of imports. The economy entered a recessionary phase that took years to shake off.

Second boom: Remittances and institutional expansion (2008-10)

The second boom emerged amid post-conflict recovery and renewed financial sector reforms. The Nepal Rastra Bank Act and Bank and Financial Institutions Act (BAFIA) liberalised licensing, causing the number of financial firms to more than double. Remittance inflows surged, providing abundant liquidity.

Credit growth reached 26.9 per cent in 2008 and 29.1 per cent in 2009. The Nepal Stock Exchange (NEPSE) index nearly tripled in two years before crashing over 50 per cent. Real GDP growth slowed from 6.5 per cent to 4.53 per cent, followed by a sharp credit contraction and negative credit-to-GDP gaps for three years.

Asset bubbles in real estate and equities burst, imports slowed, and external balances deteriorated. This cycle underscored how remittance-driven liquidity, without strong regulatory guardrails, amplified systemic risks.

Third boom: Pandemic-era Stimulus (2020-22)

The most recent boom was a direct response to the COVID-19 pandemic. Ultra-loose monetary policy, massive refinancing facilities (ballooning from Rs 22 billion to Rs 158 billion), regulatory forbearance, and near-zero interbank rates injected cheap capital. Credit growth jumped to 26.4 per cent in 2021.

GDP contracted 2.37 per cent in 2020 before partial recovery. The aftermath was severe: credit plummeted to 4.6 per cent growth by 2023, the current account deficit hit a record 12.5 per cent of GDP, and reserves covered just 7.3 months of imports. The government banned luxury imports, and the central bank imposed tight measures.

Recent analyses confirm credit to the private sector doubled relative to GDP in recent years, far outpacing peers, yet real sector growth remained sluggish, heightening boom-bust risks.

Common Threads and Consequences

Across all three booms, patterns repeat: expansionary policies, rapid institutional growth, misdirected credit toward non-tradables (real estate, imports, consumption), asset price inflation, followed by external sector stress and credit crunches. Economic growth fell below historical averages for about three years post-boom.

Broader research, including on credit-induced cycles, shows such patterns increase leverage, fuel demand in non-productive sectors, and raise vulnerability to shocks.

Current context and outlook for 2026

As of mid-2026, Nepal’s economy faces subdued credit growth amid lingering vulnerabilities. Private sector credit expansion remains modest due to weak demand, with non-performing loans (NPLs) rising to around 5.4 per cent. The financial sector stays capitalised but stressed.

Projections for FY2026 indicate slowed growth around 2.3-2.7 per cent, pressured by domestic unrest, Middle East conflicts affecting remittances and tourism, and external uncertainties. Recovery is anticipated in FY2027, potentially reaching 5 per cent, supported by hydropower and stability.

The NRB maintains a cautiously accommodative stance with low policy rates, but experts stress the need for better fiscal-monetary coordination, stronger risk-based supervision, and directing credit toward productive sectors like manufacturing and agriculture.

Rajesh Kumar Agrawal, former president of the Confederation of Nepal Industries (CNI), notes increased caution among borrowers and lenders today, but warns against repeating past policy missteps.

Policy imperatives for breaking the cycle

The NRB study serves as a stark reminder. Policymakers must enhance macroprudential tools, such as counter-cyclical buffers, to curb excessive lending. Improving credit allocation through targeted incentives for exports and industry, alongside structural reforms to boost productivity, is essential.

International lessons, from global financial crises to regional experiences, highlight that unmanaged credit booms rarely end well. For Nepal, a landlocked economy reliant on remittances and imports, building resilience against external shocks while fostering inclusive growth remains paramount.

The research underscores that sustainable development demands moving beyond boom-bust cycles toward balanced, productive expansion.