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Exchange rate status quo helps Nepal more

Nepal’s relation with India has witnessed ups and downs in past decades. But one thing that has remained constant over 17 years is the exchange rate between currencies of the two nations, reports Utpal Parashar.

world Updated: May 31, 2010 08:06 IST
Utpal Parashar

Nepal’s relation with India has witnessed ups and downs in past decades. But one thing that has remained constant over 17 years is the exchange rate between currencies of the two nations.

Indian currency is the legal tender in the neighbouring nation and Nepal’s government has kept the exchange rate at a fixed peg of 1.6 Nepali rupee for every Indian rupee unchanged since 1993.

It is this rate that has kept Nepal economy fairly stable despite political upheavals in past two decades. But there are suggestions that the country is planning to review the rate and devalue its currency.

The new governor of Nepal Rashtra Bank, Yuva Raj Khatiwada, told Financial Times recently Nepal has been “overly stressed” to maintain the peg and it needs to reconsider the rate in the medium term. He, however, added the present rate needed to be maintained in the short term for the sake of price stability. It can be changed when the country has political and economic stability, low inflation and higher reserves.

Although Nepal has an annual growth rate of nearly four per cent, it is mainly due to growth in the Indian economy and the country’s fixed currency peg with India. Double-digit inflation over several years and a Balance of Payment (BoP) deficit of over 23.5 billion Nepali rupees is severely crippling that country’s economy. Not surprisingly, Khatiwada’s views evoked negative reactions.

“Governor Khatiwada has pressed the panic button by talking about such a critical and sensitive issue at a wrong time,” wrote Raju Nepal, CEO, Citizens Bank in the Republica daily.

Many feel that such statement would make people lose confidence in the Nepali currency and lead to more holding of Indian currency — a phenomenon rampant in areas bordering India. Changing the peg could bring some short-term benefits like reducing the BoP gap and increase in exports for 2-3 months, but soon it would lead to sharp rise in prices and affect the buying capacity of consumers.

Nearly 60 per cent of Nepal’s trade is with India and Nepalis working in the neighbouring nation contribute a significant portion of foreign remittances that comprise 21 per cent of the country’s GDP. Any change in the exchange rate is bound to affect those issues as well.