Recently, few questions have emerged about the peg of Nepalese currency to Indian currency.

Questions such as: is it correct policy to peg to Indian currency?

Should Nepalese currency adopt a floating exchange rate? Or should the Nepalese currency be pegged to another currency and other related matters? These are important and serious questions that require serious thought and analysis.

I hope these issues are NOT (repeat NOT) being raised at this time when there are diplomatic and political issues with India.

From the outset, we believe that raising such a serious issue that requires the wisdom and knowledge of monetary policy professionals and experts, regardless of political mindset, is FALSE and should not be done.

With that said, let’s take a look at this question with some analytical thinking and asking a few questions.

What makes a currency strong?

Generally, a currency is said to be strong by considering the demand for the currency as well as the gold deposit of the central bank of the country.

A currency is classified as strong when it is worth more than the currency of another country. In other words, as an example, if the Indian currency is worth half the US dollar, the dollar would be considerably stronger than the Indian currency.

If the entry of foreign currencies into a country is greater than the exit, then the currency of that country will be stronger and vice versa.

Likewise, most people have strong currency myths that if a country produces more money, the currency gets stronger.

Fixed currency versus floating currency: What’s better for Nepal?

Many countries follow either a fixed exchange rate or a floating exchange rate, or both. In fact, various methods of interest rates are determined by merging fixed and floating exchange rates.

As part of the international monetary system, the gold reserve system was accepted in 1816-1914 as gold parity. The Breton Woods system accepted the fixed exchange rate from 1944 to 1971.

And, the dollar system with a flexible exchange rate was introduced in 1971.

A fixed exchange rate or a floating exchange rate determines the value of a currency. A floating exchange rate is determined by the free market and the demand and supply in the global currency market.

Usually, developing countries, for stability, opt for a fixed exchange rate because the floating exchange rate can decrease the value of the currency.

Therefore, in a floating exchange rate regime, if the demand for the currency is high, the value will increase. On the contrary, if the demand is weak, the value of the currency will decrease.

In a floating exchange rate regime, the ideal situation is when the inflows and outflows of foreign currencies are roughly equal.

If the entry of foreign currencies into a country is greater than the exit, then the currency of that country will be stronger and vice versa.

A fixed exchange rate or a fixed rate, on the other hand, is fixed against another major currency. A fixed exchange rate is set by the central bank.

In other words, a fixed exchange rate is known as a regime in which a country ties the value of its currency to another widely used commodity or currency.

Usually, developing countries, for stability, opt for a fixed exchange rate because the floating exchange rate can decrease the value of the currency.

Countries, opting for a fixed rate, often peg their currency to the currency of the country with which most trade takes place.

Nepal’s history regarding exchange rates has seen some interesting changes. Until 1957, the Nepalese currency was subject to the floating exchange rate system.

After the creation of the Nepal Rastra Bank in 1956, the currency was pegged to the Indian rupee at the rate of 100 NPR = 154.5 INR. The exchange rates between Nepalese currency and Indian currency underwent some changes thereafter (Table 1).

There have been many changes over the past 25 years and “the debate on the necessity of anchoring in Nepal” has been raised several times. While most economists argue that peg is the reason for the stability of trade and stability of Nepalese currency, other economists here believe that Nepalese currency should not stay pegged to Indian currency. Their argument is to make the country independent but at the same time they suggest that the Nepalese rupee be pegged to the US dollar.

Pegging to the US dollar is impractical, if not impossible in the current situation where Nepal’s largest trading partner is India (Table 2); therefore, until now, Nepalese currency has been linked to Indian currency.


Nepal does not have large exportable goods and Nepal’s main trading partner remains India. As Nepal’s biggest trading partner is India, and Nepalese currency is linked to Indian currency, some Nepalese citizens generally state that Nepal is highly dependent on India in all respects. Nepal receives most of its imports from India. Keeping this exchange rate stable removes any uncertainty and provides a useful market indicator for the country.

These citizens also vaguely mention that not pegging to Indian currency means reducing Nepal’s dependence on India – thinking it would be unfortunate to be based on political bias.

So the next logical question is:

What could be the impact of the removal of the Peg with the Indian currency?

One of the most common views is to reduce imports from India and / or change the exchange rate between Nepal and India from fixed to floating.

However, neither is perhaps the best solution for Nepal given the current situation in the country.

If the parity with Indian rupees is removed, the Nepalese rupees will face a sharp decline because, in the case of Nepal, foreign currency outflows are higher than inflows.

This means that all imports, including from the rest of the world, will become more expensive in Nepalese rupees.

If the peg was not maintained with India, the value of 1 INR would be equal to 3.9 NPR (based on the same growth rate of 143.83%). However, this scenario is only a hypothesis with assumptions.

If the exchange rate changes from fixed to floating, given Nepal’s terms of trade in the international market, the exchange rate between Nepalese currency and foreign currencies could increase dramatically, to the detriment of Nepal.

Therefore, a floating commercial rate does not seem viable for Nepal at present.

In 1993, as mentioned above, Nepalese rupees were pegged to Indian currency at the rate of 1 INR = 1.6 NPR.

During the same period, $ 1 = NPR 49.59. The current value of 1 USD is equal to 120.89 NPR (exchange rate between Nepal and USA on June 28, 2020).

Suppose Nepal did not maintain the peg with India in 1993, but instead opted for a floating exchange rate system. The growth rate of NPR in USD from 1993 to present is 143.82%.

If the peg was not maintained with India, the value of 1 INR would be equal to 3.9 NPR (based on the same growth rate of 143.83%). However, this scenario is only a hypothesis with assumptions.

Thanks to this, we can observe that if Nepal removes the peg with India, the value of Nepalese currency would depreciate considerably.

As for reducing import dependence on India, Nepal’s production and manufacturing sectors have not been able to thrive. Therefore, before reducing imports, increasing production and manufacturing in Nepal is of the utmost importance.

Given Nepal’s poor and unfavorable policies to revitalize the industrial base and agricultural sector, domestic production may not increase.

Some vital elements such as tax and tariff easing, market guarantee and agricultural subsidies are still not granted by the Nepalese government and have not created an environment for removing the anchor. possible.

At the same time, businesses are struggling to thrive as the shortest distance between the seaport and Kathmandu is on average 11 days (round trip) (Calcutta seaport).

So if the peg is revised, imports would be more expensive, putting the burden on consumers. In addition, Nepal’s main import product is petroleum products, which is a necessity.

Our point of view:

We believe that “Changing the fixed rate between Nepal and India may not be the best strategy at the moment”.

(Co-written by Swastik Aryal)


Source link