One peg too many

The Nepali rupee has appreciated against the US dollar to a nine-year high point. This trend is not an unmixed blessing for Nepal, as the appreciation has happened not on the intrinsic strength of its currency but on the strengthening Indian rupee against the dollar. And the Nepali currency has been pegged to the Indian rupee since Nepal switched over from a fixed exchange rate system to a floating rate regime based on a basket of currencies. But it maintained a fixed exchange rate regime with the Indian rupee, which acts as the benchmark for the Nepal Rastra Bank while setting the day-to-day exchange rates of the Nepali rupee with third-country currencies. The latest exchange rate of one dollar stands at 66 Nepali rupees plus, something witnessed in May-June 1998, and well below the high the dollar had touched somewhere between 70 and 80 rupees. Monetary experts think the Indian currency will keep rising against the greenback, which, in turn, translates into the continued rise of the Nepali currency vis-a-vis the dollar. The US currency has been weakening against major currencies during the past several years.

In India, the banks are reported to be selling dollars under their statutory obligations while its foreign exchange reserves have crossed the $200 billion mark, naturally lessening the demand for dollars and pushing its value down. While an official at the foreign exchange department of the Nepal Rastra Bank claims that the rising rupee will not affect the Nepali economy unfavourably, many economists think otherwise. The Indian economy is growing at a robust rate of 8 per cent, with inflation kept within reasonable limits, whereas Nepal’s growth rate is just keeping pace with the population growth rate, and its inflation rate is approaching a double-digit figure. The new contrasting economic realities of the two are certain to have their impact on the existing exchange rate determined more than a decade ago.

Indian currency reserves in the country’s banking sector have sunk low for some time. Nepal is hungry for the Indian currency as it is a net importer from India by far; therefore, it has to buy billions of Indian rupees from time to time by spending precious dollars. A question naturally arises whether time has not come for Nepal to review its exchange rate regime with India. Realism would demand, as many economists say, that Nepal should devalue its currency against the Indian rupee. Indeed, any exchange rate should reflect the true strength of the currency, if distortions in the economy are to be avoided. A fixed peg has also sharply weakened the NRB’s ability to enforce effective monetary measures aimed at exerting a restraining influence on inflation. It must not be kept artificially too high or too low. And there is not much disagreement among economists that it is at present rather on the lower side. In this light, a review of the existing exchange rate with the Indian currency is overdue, so also is the concept of the peg to the Indian currency, as some economists suggest.