In February 2009 when I came to Australia I had to exchange at the rate of Rs 50 per AUD but now Nepali agents are giving Rs 89 for every dollar sent back home. Sending dollar home supports our family and the economy as a whole but is it rational to be happy when we get more rupees for the same dollar? The question we have to ask is not “how much rupees we get for a dollar now” but “what can we buy for those rupees back home”? When I look at the historical data, in 1995 we didn’t even have to pay Rs 30 for a kilo of sugar when the exchange rate was around Rs 50 per USD, whereas now, the exchange rate is just above Rs 80 per USD but the price of sugar has more than doubled.
During March 2008 we had to pay nearly Rs 63 to buy one dollar but a year later it was just above Rs 80 for a dollar. Similarly, from July 2011 until now, Nepali Rupee has depreciated from 69/USD to above 84/USD. Like any other market, demand and supply for money created by import/exports, interest rate differentials, buying and selling of foreign currency, public debt, inflation differentials or speculative moves determine the exchange rates but one major cause that originated externally and led to these two significant depreciation of Nepali rupee is the “crisis”, the first one that started in the US known as Global Financial Crisis of 2008 and current European Debt crisis. Short-term traders in the financial markets take flight from risky assets (shares, currencies, commodities, etc) to land in “safe haven” currencies like US Dollar, Japanese Yen and Swiss Franc when they sniff crisis, which makes the sold currencies cheaper.
During crisis period even long-term investors sell their assets (investments) in emerging markets like India and China, where returns are high during normal times. When foreign investors sell their assets in India they also sell Indian Rupee for hard currencies like US Dollar and British Pound putting downward pressure on the local currency. As Nepali currency is tied with Indian currency at NPR 1.60 per IC, depreciation of IC will result in devaluation of Nepali Rupee proportionally. Or an opportunity is created for currency arbitrage (immediate purchase and sale of a currency in different markets to profit from unequal prices). Besides that, crisis results in less demand, less production, reduced trade and growth rate which will further put pressure on the exchange rate in the long run.
Depreciation of currency has both positive and negative effects. Our exports become more attractive to foreigners when our currency is cheaper, thus, our policymakers should encourage export industries to earn hard currencies at these time of cheap rupee and become less dependent on imports. The success of Southeast Asian Countries (Korea, Indonesia, Malaysia, Philippines, Thailand and Singapore) right after the Asian Crisis of 1997 is mostly contributed to the currency depreciation that initially sparked the crisis.
For a country like Nepal where remittance and foreign aid are major sources of income, depreciating currency may be welcome for many but cheap currency makes imported goods (staples, fuel, imported electronics, foreign tuition fee, international travel etc) more expensive, possibly resulting in overall price rise (inflation). For example, if the price of crude oil increases in the international market, prices of goods and services increases because of higher transportation and manufacturing costs involved in providing those goods and services, resulting in higher cost of living.
However, policymakers are reluctant to appreciate strong currencies as it hurts the export industry. Recent and most notable interventions against currency appreciation took place in 2011 when countries like Japan and Switzerland took direct measures to stop their appreciating currency while the US printed more money (Quantitative Easing) to keep the dollar low. Beside price level and exports, stable exchange rate is one of the major ingredients to attract Foreign Direct Investment which Nepal is in urgent need of.
Inflation
Even bigger worry among general population and central bankers is “inflation”. Inflation is a stuff that everybody wants a little of (growing economy creates inflation) but they are scared of excess (money worth less) and deflation, a negative inflation (which cuts investment, production and work force). Central bankers use various policy measures like interest rates movement, reserve ratio requirement, purchase and sell of bonds etc to manipulate demand and supply of money in the market to achieve required growth and to keep inflation under control. One most frequently used policy is the determination of interest rate by the central bank to achieve growth and control inflation. As central bank reduces interest rate, investors are willing to borrow and invest more as cost of capital decreases resulting in higher growth and decrease in unemployment, but as more money circulates in the economy the price level of goods and services increases too creating inflation. So central bank increases the interest rate to bring inflation down which also reduces growth. Thus the cycle continues.
Nepal Rastra Bank, like any other central bank can direct the flow of money in the economy using various policy measures but it does not really have the capacity to stir inflation which is currently running around 9.6 percent (the actual prices consumers pay are far higher and more volatile than the rate published by the government). The rising everyday prices in recent years are again a reflection of inflation in India which is the outcome of natural and artificial shortages of specific food items like onions, growing population and rising income level of Indian population.
Indian policymakers are now more worried about slow growth than high inflation. As India mulls easing its monetary policy (like in China) it might result in even higher prices. India can afford to have higher inflation rate temporarily as it is backed by similar growth rate and higher income level. But we can’t afford similar inflation in Nepal because it won’t be a reflection of higher investment, accelerating growth and rising incomes. Lack of infrastructure and investments, dependence on remittance and foreign aid, trade dependence and open border with India, excessive imports and insufficient primary industries are few reasons that we are highly exposed to external causes.
We can’t be totally immune from exogenous shocks but we should be able to absorb these shocks without much pain. This integrated world is a battleground. A 100 year ago countries would have fought with guns and tanks, not anymore; now we fight the trade war using currencies and trade policies as weapons. To survive and prosper we have to be a player not the played one. For that we need to build human and physical capital by bringing about long term structural changes rather than short term and politically influenced ones.
The writer is a post-graduate student in economics, Macquarie University, Sydney
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