The Monetary Policy and Programme (MPP) for the current fiscal year, the only national policy document that does not require the formal approval of the government or the eight political parties, announced by the Governor on July 23, give all some hope, now a rare commodity in the country. In particular, the Governor and his team have clearly explained what monetary policy can or cannot do and, in that process, reject even the target announced by the Finance Minister in the Budget Speech, for example, with respect to growth in income and national inflation rate, and forward a relatively realistic goal. In some areas, however, it knows the problems as well as the causes for its origin and growth but cannot do anything for the reasons that the central bank itself does not seem to be fully convinced of. It is, therefore, legitimate to doubt in a few areas what is written in the policy announcements, what will

actually be implemented, and what will be the result may turn out to be three different things.

One of such areas is the management of foreign exchange and the realistic exchange rate vis-a- vis Indian currency, including the appropriateness of rapid appreciation of the value of Nepali currency vis-a-vis the US dollar. It is true that the foreign exchange reserves of both India and Nepal are high and rising at a rapid rate but for different reasons. In India, the recent rise in foreign reserves is due to high growth in domestic economic activities and the associated inflow of foreign resources for investment; in Nepal it is due to income from remittances from Nepali workers. As a result, the demand for bank loans in India is very high which has helped to increase the interest rate in deposit too. In Nepal, the deposit rate, adjusted for the inflation rate, is negative as there is no strong demand for financial resources for investment due to sluggish economic activities.

This is precisely the reason for capital flight from Nepal that a few economists are complaining openly in recent weeks. The outflow of capital plus the deficit in trade account has resulted in high deficit in the balance of payments with India. This has led to the shortage of Indian currency in the country which the Nepal Rastra Bank has tried to meet from two sources, namely, (i) by allowing import of a number of goods — totalling, according to a reliable source, almost fifty percent of import — from India by paying in convertible currencies and (ii) exchanging convertible currencies for the Indian currency with the Reserve Bank of India (RBI). In the last fiscal year, Nepal Rastra Bank has sold $ 920 million to the RBI for Indian currency. It is also possible that a significant part of IC thus received may flow back again to India due to difference in deposit rate between the two countries, and expected devaluation of Nepali currency in the near future.

The basic question that has yet remained to be answered is: is it not a misuse of India’s assistance to maintain unrealistic exchange rate? Any measures to support current practice, including the facility provided by RBI, will help the political leaders to follow a decision contrary to national interest as is the case now.

Had India refused to provide Indian currency in exchange for the convertible currency like the dollar, Nepali currency would have been devalued a long time ago. It is interesting to note that International Monetary Fund can not provide loan in Indian currency but only in convertible currency, which both India and Nepal have in abundance.

It is not possible to follow India’s policy on exchange rate month in and month out on a sustainable basis. We have also to develop a realistic rate to peg with the currency of our main trading partner with a market that is expected to reach Rs.112 trillion by 2017. This is a bit complicated issue that needs a detailed study. Our policy makers, however, do not bother to go into detail. Therefore, in a letter written jointly by the Finance Minister and the Governor on May 30 — fifty-two days before the presentation of MPP — to the Managing Director of IMF, they have mentioned that “the level of exchange rate peg (with Indian currency) is appropriate “indicating there will be no change in foreign exchange regime and exchange rate. They never bothered about the availability of Indian currency due to the facility provided by RBI!

This also helps the authorities to delay the correction in inconsistency in policy measures. For example, the Government of Nepal is committed to maintain free con- vertibility of the Nepali currency into Indian currency and vice-versa. We are, however, permitted to hold IC only in cash not in bank deposits while with respect to other currencies the commercial banks are authorised to open interest bearing accounts for both individual and institution. This discriminatory practice must end which will help to end many of the current problems that I hope to discuss some other time.

Dr. Pant is executive director of the Institute for Development Studies (IfDS)