Effects of Fixed Exchange Rate Between Indian Rupee and Nepali Rupee
Nepal has maintained the fixed exchange rate between NPR and INR (i.e. 100 INR = 160 NPR) for more than 3 decades. During this period, the relative strength of the Nepalese economy has been weaker, as evidenced by increasing and large trade deficits with India, as well as a slower growth rate of the Nepali economy compared to India.
Such a fixed exchange rate, maintained for more than three decades, has both positive and negative implications for the Nepalese economy.
Positive Implications
- Predictable exchange rate certainty has made trade and investment between Nepal and India more sustainable.
- Increased access to the Indian market and the product being in the Indian market.
- No speculative hoarding in INR and better circulation of it to promote economic activities.
- Able to maintain monetary discipline through a fixed rate with INR.
- Improve confidence with NPR for foreigners due to its fixed exchange rate with INR.
- Benefited the economy as a small economy dependent with large economy by avoiding an exchange rate crisis.
Negative Implications
- Unable to execute an independent monetary policy, which has to consider the Indian interest rate, inflation, and its policy.
- Pressure on maintaining a favorable BoP due to an increase in a large trade deficit with India.
- Use of large forex reserve in the import from India in order to maintain the fixed exchange rate.
- Growth of parallel on informal market leading to informal trade between India and payment through Hundi like mechanism.
- Appreciation of the real exchange rate makes Indian products relatively cheaper and unable to compete with Indian products and avoid trade concentration with India.
“Real exchange rate को appreciation” भन्नाले हाम्रो देशको मुद्रा भारतीय रूपैयाँको तुलनामा बलियो हुनु हो। जब हाम्रो मुद्रा बलियो हुन्छ (Appreciate हुन्छ), त्यति बेला भारतबाट आउने सामानहरू हाम्रो बजारमा सस्तो देखिन्छन्।
यसको कारण के हुन्छ भने, नेपाली उपभोक्ताले भारतीय सामान सजिलै सस्तोमा पाउँछन्, तर नेपालमै बनेको उत्पादन महँगो देखिन्छ। फलस्वरूप, नेपाली उत्पादनहरू भारतीय उत्पादनसँग प्रतिस्पर्धा गर्न सक्दैनन्। यसले गर्दा बजारमा भारतकै सामानको प्रभुत्व बढ्छ, जसलाई trade concentration with India भनिन्छ।मानौं,
- १ भारतीय रूपैयाँ = १.६० नेपाली रूपैयाँ थियो।
तर अब “real exchange rate appreciation” का कारण- १ भारतीय रूपैयाँ = १.५० नेपाली रूपैयाँ भयो।
यो अवस्थामा:
- भारतमा १०० रूपैयाँको चप्पल = पहिले १६० रुपैयाँ पर्थ्यो।
- अहिले त्यही चप्पल = १५० रुपैयाँ मात्र पर्छ।
- यति बेला नेपालमा बनेको चप्पलको मूल्य १५५ रुपैयाँ भए पनि उपभोक्ताले भारतकै चप्पल सस्तो ठानेर खरिद गर्छ। यसरी नेपाली उत्पादन महँगो देखिन्छ र प्रतिस्पर्धा गर्न सक्दैन।
अन्ततः, बजार भारतीय उत्पादनमा मात्र निर्भर (trade concentration) हुन पुग्छ। मुद्रा बलियो हुँदा (Appreciation) विदेशी अर्थात् भारतीय उत्पादन सस्तो देखिन्छ, जसले गर्दा नेपाली उत्पादन प्रतिस्पर्धा गर्न नसकी बजार भारतकै सामानमा भर पर्छ।
Whether to continue existing exchange rate system or change?
There is a debate among the policy maker, academician and the private sector regarding the fixed exchange rate between India rupee and Nepali rupee. In order to maintain such fixed rate, NRB has to spend billions of forex to buy INR and supply in the market. This has appreciated the real exchange though nominal exchange rate is fixed.
Appreciation of Real Exchange Rate = हाम्रो मुद्रा बलियो हुनु = विदेशी सामान सस्तो, हाम्रो सामान महँगो → आयात बढ्छ, निर्यात घट्छ।
Nominal Exchange Rate (NER)
- दुई देशबीचको मुद्रा विनिमय दर हो।
- यसमा मूल्यस्तर (inflation) लाई विचार गरिँदैन।
- सामान्यतया बैंक वा बजारमा देखिने दर यही हो।
- १ अमेरिकी डलर = १३५ नेपाली रूपैयाँ । यो nominal exchange rate हो।
Such appreciation of NPR has weakened the competitiveness of Nepali products against the Indian product which cause the large trade deficit. So, the debate on reassessment of existing fixed exchange rate is frequently expressed by the stakeholders.
In this context, the change in existing exchange rate between the NPR and INR has both positive and negative consequences. The positive effect may be in the form of improving competitiveness of Nepali product while the negative implication may be in the form of increasing inflation immediately which has not only economic but also the political cost.
So, this is necessary to assess the alternative possibilities on the existing exchange rate system such as
- Changing in exchange rate system
- Devaluation of NPR against INR and continue to fixed exchange rate system
- Continue existing exchange rate system
Changing in exchange rate system
Regarding the first option, we can adjust the flexible or crawling peg system.
Crawling Peg System भनेको exchange rate प्रणाली हो, जसमा विनिमय दरलाई सानो–सानो मात्रामा क्रमिक रूपमा परिवर्तन गरिन्छ, ताकि मुद्रा न त पूर्ण fixed होस्, न त पूर्ण floating।
If we adopt the flexible exchange rate system, Nepal can not maintain the system immediately because of the huge deficit with India. This sharply depreciate NPR and there will be huge speculative hoarding and may lead to exchange rate crisis given the limited capacity of economy.
Similarly, under the crawling peg system, the exchange rate is gradually adjusted to avoid the appreciation or depreciation of real exchange rate and it is adjusted based on specific rate to maintain the fixed or pegged rate.
Devaluation of NPR against INR and continue to fixed exchange rate system
The second option is to devaluate NPR against INR and maintain the optimum rate at which both nominal and real exchange rate are equal. Since, it has a huge political cost, it requires a reliable study with good communication to the common people and common consensus among the major political parties.
Continue existing exchange rate system
The third option is to continue the existing rate and the system which requires sufficient forex reserve to maintain. If we are able to manage such forex reserve for long time, there is no wrong with continuing this system but the government should make private sector friendly environment with adequate support and incentive in order to improve the cost of doing business and make the Nepalese product more competitive.
Therefore, the existing fixed exchange rate can be continued if we expect the sustained sources of forex for long run while flexible exchange rate can not be the immediate option. If the government expect forex reserve which is historically high in this couple of years can not be sustained then devaluation or crawling peg system can be adopted. However, changing the exchange rate is much sensitive issue which directly hits to the cost of living in the common people, the government should develop a common consensus among the political parties and well-communication to the general public.