Liquidity Regimes in Nepal: The Four-Phase Framework

First published 21 Aug 2026 · Last verified 7 Sep 2026

The credit cycle and the policy transmission channels described in Chapters 0.1 and 0.2 do not exist on a continuous spectrum. In Nepal’s market, these forces cluster into discrete phases — liquidity regimes — in which the dominant market dynamic is clearly identifiable and relatively stable for months to years at a time.

This chapter formalises those regimes into a four-phase framework that the investor can use as a positioning map: not to predict the future with certainty, but to know which regime they are currently in, what the dominant risks are in that regime, and how portfolio construction should change accordingly.

0.3.1 — Defining Regime: Why Discrete Phases Outperform Continuous Indicators for Investment Positioning

A regime is a stable configuration of market conditions — credit availability, liquidity levels, risk appetite, policy direction — that persists for a meaningful period and produces predictable patterns in asset prices. The regime concept is more practically useful than continuous indicators for several reasons:

1. It forces threshold thinking: Rather than asking ‘is credit growth slightly better or slightly worse this month’, regime analysis asks ‘has the system crossed from one qualitative state to another’. Threshold crossings are more actionable than marginal changes.

2. It anchors strategy: Within a regime, the dominant risks and opportunities are known. The investor does not need to re-evaluate their entire portfolio framework every month — they need to execute the regime-appropriate strategy consistently until the regime changes.

3. It prevents overtrading: Continuous indicator monitoring leads to constant small portfolio adjustments that increase transaction costs and reduce conviction. Regime investing involves infrequent, high-conviction strategic shifts.

4. It accommodates uncertainty: Regime identification is not perfect. There are transition periods of 2–4 months when the regime is ambiguous. The four-phase framework handles this explicitly — the transition phase has its own positioning rules.

The Four-Regime Map Overview

Table 0.3.1 — The Four-Phase Liquidity Regime Framework Overview

Historical Context: Two Cycles, Now Three

Nepal has now lived through approximately two and a half cycles of this framework since 2010. The 2016–17 bull market and subsequent correction was a compressed cycle. The 2019–2022 expansion and 2022–2023 correction was a more extreme version — NEPSE’s run to its August 2021 peak near 3,200 and collapse to roughly 1,780 by mid-2022 remains the defining demonstration of what the compression phase can do to an unleveraged portfolio, let alone a leveraged one. And the cycle now completing its arc — expansion from the 2022 lows through the 2024–26 re-rating to nearly 3,000, followed by the 2026 pullback — is providing the freshest case study this framework has ever had. Each cycle exhibited the four phases in the sequence described, with durations consistent with the ranges above.

0.3.2 — Phase 1 — Expansion Regime: High Deposits, Credit Growth Above 20%, Loose Margin Lending

Defining Characteristics

Table 0.3.2 — Phase 1 Expansion Regime Diagnostic Indicators

What Is Happening in the Economy

Remittance inflows are strong. Deposit growth is feeding credit expansion. Banks are competing aggressively for loan customers. Interest rates are relatively low — both lending rates and fixed deposit rates. The cost of capital for businesses is manageable. Hydropower projects are drawing construction loans. Microfinance institutions are expanding their borrower bases. Retail investors, seeing rising share prices, are borrowing against those shares to buy more.

Earnings across the market are growing. P/E and P/B multiples are expanding because the market is forward-pricing continued earnings growth. IPO activity is high, and listing day premiums are large.

The Late-Phase Warning Signs

The expansion regime contains within it the seeds of its own termination. The investor who fails to recognise the late-phase warning signs will give back a significant portion of the gains accumulated during the expansion:

• Credit growth exceeds 20% for two or more consecutive quarters — lending standards are deteriorating

• CD ratio approaches the regulatory ceiling — the constraint that ends every Nepali expansion is re-engaging

• Margin loan balances grow faster than the deposit base for a year — the leverage pyramid is steepening

• Interbank rate drifts persistently above the corridor’s midpoint — the surplus is draining

• New investors open demat accounts at record pace while IPO premiums hit triple digits — the marginal buyer has no history

Where the Framework Meets September 2026

Here is the framework’s honesty on display: several Phase 1 liquidity characteristics are present right now — deposits growing 13–15 percent, CD ratio near 74 percent, interbank below the corridor floor, record remittances, NRB actively absorbing surplus. But the defining Phase 1 characteristic — credit growth above 15 percent — is absent (6.6 percent for FY 2082/83), and the NPL ratio, at roughly 5.4 percent, is only now cresting rather than resolved. A regime reading that checks boxes across two phases is a transition reading — and transition positioning rules (Section 0.3.7) exist for exactly this situation.

0.3.3 — Phase 2 — Compression Regime: CD Ratio Binding, Remittance Slowdown, NRB Tightening Active

Defining Characteristics

The compression regime begins when the banking system hits its constraints: the CD ratio binds at its ceiling, remittance growth slows, and NRB — its inflation and external-sector warnings triggered — shifts from accommodation to active tightening. Deposits become scarce and expensive. Interbank rates spike above the corridor ceiling. Banks compete for deposits with progressively higher fixed-deposit rates, and margin loans are the first casualty of their funding squeeze.

The Defining Nepali Case: 2021–22

The compression that followed the 2021 mania is the framework’s starkest lesson. Through late 2021, the CD ratio pressed against its ceiling, interbank rates ran hot, and margin balances sat at records against collateral values that had never been higher. When the turn came, the sequence was mechanical: margin calls forced selling; selling broke prices; broken prices triggered further margin calls; banks, squeezed for funds, cut share-collateral lending hardest. NEPSE fell from nearly 3,200 to roughly 1,780 — a fall of over 40 percent — while the real economy’s damage was still to come through 2022–23 as the credit channel bit into earnings.

Note what the compression did not require: no war, no pandemic, no fraud. A leveraged market hitting a binding funding constraint was sufficient. This is why regime investors hold cash through late expansions not as timidity but as pre-positioning for the only phase in which cash is king.

Positioning in Phase 2

Reduce equity exposure systematically — not in one dramatic sale, but through the discipline of trailing exit rules (Chapter 58’s circuit-trap modelling exists for this phase). Shift proceeds to fixed deposits, which in compression phases finally pay properly — the 2022/23 FD rates above 10 percent were the compensation for the phase’s risk. Refuse new margin borrowing absolutely. The compression phase punishes every behaviour that worked in Phase 1.

0.3.4 — Phase 3 — Balance Sheet Repair Phase: NPL Rising, Provisioning Heavy, Earnings Depressed

Defining Characteristics

After the correction, the economy enters the longest and least exciting phase: balance sheet repair. Credit growth is weak (often 5–10 percent). The NPL ratio climbs with a lag — peaking 12–24 months after the correction itself — as restructured loans fail and renewal culture can no longer disguise distress. Banks provision heavily; earnings trough; P/B multiples sit at multi-year lows despite recovering deposit conditions. NEPSE drifts sideways in a wide range. It is the phase with the least price action and the most fundamental change.

The Nepali Case: 2022–24

The repair phase following the 2022 compression ran on schedule: system NPLs climbed from the neighbourhood of 1.5 percent to roughly 5.4 percent at the cycle crest; provisioning consumed bank profits for two years; microfinance distressed most, its borrowers furthest from income buffers; and NEPSE spent 2023–24 range-bound near the low 2,000s while the index’s banking core rebuilt from the inside. Through it all, the external sector was quietly healing — remittances compounding, reserves rebuilding from the seven-month threshold toward what would become eighteen months of import cover — laying the monetary groundwork for the next phase.

Reading the Exit From Phase 3

The repair phase ends not when NPLs return to old lows — that takes years — but when three signals align: the NPL ratio crests (its rate of increase slows to zero, even at a high level); policy language shifts from discipline to revival (the FY 2083/84 monetary policy’s commitments on distressed-industry NPL management and loan revival are precisely this language); and funding costs break lower (the FD maturity wall repricing into a falling-rate world). The investor who waits for NPLs to look clean has missed the phase: the whole return of Phase 4 is compressed into the window when the repair is visibly ending but not yet reported as done.

0.3.5 — Phase 4 — Recovery Regime: NRB Easing, Credit Unlocking, Equity Re-Rating

Defining Characteristics

The recovery regime begins when NRB, satisfied on inflation and the external sector, moves from tightening to active easing — and it is the phase with the most favourable risk-reward in the entire cycle, because asset prices are still priced for the repair phase while liquidity is already flooding back.

The Nepali case ran from 2024 into 2026 and deserves a precise recounting, because every element was visible in policy documents months before it appeared in prices:

• Policy rates were cut step by step — the policy rate travelling from 6.5 percent through 5.5 and 5.0 percent in 2024 down to 4.25 percent, with the bank rate falling to 5.75 percent and the corridor floor to 3 percent.

• The margin channel was structurally reopened — the July 2024 abolition of the Rs 20 crore institutional share-collateral cap, broker margin infrastructure expanded, and by FY 2083/84 limits being set on risk-based institutional strength.

• Remittances exploded to a record Rs 2,363 billion for FY 2082/83, driving deposits to 13–15 percent growth while CD headroom widened to sixteen points.

• Bank earnings inflected on funding-cost relief — NIMs widening as the 2022/23 FD wall repriced down — while the NPL ratio crested near 5.4 percent.

• NEPSE re-rated from the low 2,000s to a touch under 3,000 by March 2026 — led, exactly as Chapter 0.2’s transmission ordering predicts, by banks and rate-sensitives, on liquidity that preceded credit (which grew only 6.6 percent).

The False Recovery Signal — and the 2026 Test

Phase 4’s defining risk is believing the recovery is Phase 1 before credit growth confirms it. A re-rating carried purely by deposit liquidity and falling rates — without the broadening of earnings that credit expansion brings — is a recovery on one leg. The mid-2026 pullback from ~2,950 to the mid-2,500s is the framework’s live tutorial: liquidity indicators remained loose throughout (no compression signature: interbank stayed under the floor, the CD ratio stayed far from its ceiling, NRB was absorbing rather than draining), which distinguishes a one-legged recovery digesting its gains from the start of a new compression. The confirmation that separates a resumed Phase 4 run from a genuine Phase 1 expansion is a single number: credit growth re-accelerating through 8–10 percent. Until it prints, position for recovery; do not yet position for boom.

0.3.6 — Government Capex Cycle Overlay: How Budget Spending Interacts With NRB Liquidity

NRB’s liquidity regimes do not operate alone. Overlaid on all four phases is the government’s fiscal cycle — the budget’s capital expenditure rhythm — which can amplify or dampen the regime in force.

The Mechanics

Government capital expenditure injects liquidity directly: contractor payments, supplier bills, and wages become bank deposits that join the remittance-funded pool. In expansion and recovery phases, strong capex adds fuel to already-strong deposit growth — the multiplier of Chapter 0.1 running with an extra cylinder. In compression phases, weak capex (execution always suffers when liquidity is scarce) deepens the slowdown. The typically perverse pattern: capex surges in the final months of the fiscal year (Asar), producing a June liquidity pulse that seasonal analysts must adjust for.

The Current Overlay

The 2025/26 fiscal year ended with an unusually favourable fiscal backdrop: reserves covering eighteen months of imports, remittances at record levels, and headline inflation that had cooled to the 5-percent neighbourhood — giving the budget genuine room. The FY 2083/84 targets (7 percent growth, inflation around 5.5 percent) presume exactly this space. For the regime analyst, fiscal strength is a confidence variable: it raises the probability that the recovery’s next leg arrives through credit demand (government-backed infrastructure and contract activity pulling private lending behind it) rather than through the slower route of organic business borrowing. Watch budget execution numbers — actual capital spending, not announcements — as the overlay’s monthly tell.

0.3.7 — Regime Identification Checklist: The Six Data Points That Confirm Which Phase You Are In

The framework earns its keep in identification. Six data points, updated quarterly, are sufficient — and every one of them is free from NRB’s own publications.

Table 0.3.3 — The Six-Point Regime Checklist, September 2026

Reading the Verdict — Including When It Is Ambiguous

Four of six data points say recovery-to-expansion liquidity; one says the repair is not finished; one says the market has already run ahead and is digesting. The honest verdict: late Phase 4 — a recovery still awaiting its credit confirmation — in a transition zone, not a clean regime. The framework’s transition rules then govern:

• Position in half-steps: neither full recovery commitment nor defensive retreat — sized so that either resolution can be followed, not feared.

• Let two numbers make the decision: credit growth sustained above 8–10 percent converts the verdict to Phase 1 (and justifies full expansion positioning); deposit growth falling below ~10 percent with credit still weak converts it back toward Phase 3 caution.

• Re-check quarterly, at the NRB report dates — not daily. Regime analysis deliberately runs on a slower clock than the market’s noise.

0.3.8 — Portfolio Positioning by Regime: How Your Sector Weights and Cash Level Must Change With Each Phase

Regime identification matters only because portfolio construction must change. The full mechanics live in Part XII; this section gives the positioning skeleton each regime demands.

Table 0.3.4 — Portfolio Positioning by Regime

The Sector Notes, Sharpened for Now

• Banks: the recovery’s engine via NIM expansion and provisioning relief — already partly delivered through 2025; the next tranche of bank upside belongs to the credit channel (loan growth), which is why the 8–10 percent credit threshold doubles as the banking sector’s earnings signal.

• Hydropower: the project finance channel’s beneficiaries — today’s abundant, cheap construction debt is tomorrow’s COD schedule; the sector’s earnings inflection lags its funding inflection by years, which patient investors can use.

• Microfinance: the repair phase’s heaviest casualty remains the recovery phase’s highest-beta recovery — the FY 2083/84 revival provisions for distressed-industry loans fall disproportionately here. Highest risk, highest sensitivity to the regime turning.

• Insurance: the quiet beneficiary of every regime — float income tracks the interest rate path, and falling rates now cost less than they used to with reserve cover at eighteen months of imports stabilising the long end of the picture.

The Discipline That Makes It Work

The four-phase framework fails exactly one way: using it as a prediction rather than a posture. It does not tell you the index will be 3,000 or 2,300 next Asar. It tells you which behaviours the current environment rewards, which risks it hides, and which single data point would change your mind. In September 2026 that number is credit growth. Find it quarterly, respect the thresholds, and let the regime — not your emotions, not the market’s mood — set the terms of engagement.

Chapter recap

Nepali market conditions cluster into four regimes — expansion, compression, balance-sheet repair, and recovery — each with characteristic NRB behaviour, market tendencies, and portfolio demands. The framework’s power is in identification: six free data points, checked quarterly, are enough. As of September 2026 they describe a late recovery — liquidity loose and deposit-rich, credit still unconfirmed, NPLs cresting, a one-legged re-rating digesting its gains — governed by transition rules and a single confirmation number. Position for the regime you are in, watch the number that would end it, and let thresholds rather than emotions move your money.