A rapid and steep decline in value of our currency (NPR) has created fears of double digit inflation. The recent decline in the currencies of emerging market economies has caused consternation and panic, dampening the prospects of growth. Most of the discourse about the falling currency has been focused on high inflation, loss in confidence of investors, slowdown in output growth, and reduced ability to finance imports. With currency volatility, the resilience of our economic fundamentals is under scrutiny.
Depreciation leads to a decline in the value of a currency vis-à-vis any other currency. Deprecation is a market adjustment and takes place through interplay of different factors. The impact and implication of depreciation of currency vary from actor to actor—such as individuals, households, migrant workers, tourism sector, financial institutions, central bank, traders, government, etc. It is so because economics, unlike physics and other natural sciences, deals with real people who are dynamic, undertake diverse activities, and have different expectations at any given point of time. There are multiple dimensions and implications of depreciation of currency. Panic driven discourse of instability is just an aspect of a complex and intricate mechanism.[break]
Monetary policy in Nepal is circumscribed by fixed exchange rate and absolute capital control, which means restriction in the movement of foreign currency from Nepal. Nepal Rastra Bank cannot intervene in the precipitous fall through conventional monetary policy. With a fixed exchange rate system, value of our currency is dependent on the Indian currency (INR). One of the foreseeable risks of falling NPR is a rise in general price. A decline in rupee makes our dollar denominated imports dearer. Primarily, it will affect cosmopolitan import-dependent residents of major cities. For instance, to buy an iPhone costing US $400, a Nepali consumer will need to pay a higher price at exchange rate Rs. 106 compared to a year ago when the exchange rate was Rs 74.
Similarly, India being our major trading partner, inflationary tendencies in India have a cascading effect in Nepal. Inflated price in India due to falling INR will push up domestic inflation by increasing the value of goods imported from India.
Amidst the gloomy predictions of a declining NPR, we must carefully examine the recent phenomena. The externally pushed or falling currency led inflation is short lived. In our case, a falling rupee will come to equilibrium depending on Indian macroeconomic performance in the coming days. The moment currency value reaches equilibrium, the exchange rate induced inflation will stabilize. So, instead of fearing the ghost of short lived inflation, we should look at the positives that come with a falling rupee.
The major highlight of a falling NPR is the rise in income and wellbeing of remittance receiving households. The moment NPR falls against US dollar, the convertible value of remittance in NPR will increase, leading to a rise in income. The shift in income reduces the vulnerability of the dependents of migrant workers, and also adds to the consumption basket. As majority of remittance dependent household lie at the bottom of the prosperity pyramid, given the preference and affordability, they spend mostly on domestically produced goods and services. This may fuel entrepreneurship and rural economic activity.
Nepali imports are almost eight times the level of exports. Falling currency gives the opportunity to reduce current account deficit by increasing exports and revenue of tourism sector, and reducing the total value of imports. Now, Nepali exports are competitive in the international market as importers can buy them for a reduced amount. Also, declining currency reduces the purchasing power of our income, and hence the total value of imports. A rise in the price of imports will induce people to restrict consumption of imported good and substitute some imports with locally produced goods and services. Similarly, tourism sector can also look forward to a better growth trajectory as Nepal will be a cheaper destination to explore compared to other countries where the currency remains strong, like Thailand.
The economic landscape of Nepal could shift from being import driven to export specialized, and sustain current account surplus. The government can achieve this landmark by promoting export and tourism sectors because they are more competitive today than they were at Rs 64 per dollar. Trade deficit stood at Rs. 351,671.7 million in the first nine eleven months of FY 2069-70. Our International reserves stood at US $ 4,679.70 million (Rs. 496,048.2 million as of April 2013), which is enough to finance imports of at least 10 to 12 months (all figures from Quarterly Economic Bulletin, Volume 47 published by Nepal Rastra Bank). Despite downward correction in our currency, the reserves are enough to absorb shocks.
However, a rapidly declining currency can play havoc on financial institutions if they have substantial debt in foreign currency. Our commercial banks have foreign Assets worth Rs 86,355.4 million as of April 2013, which is approximately US $ 814.7 million at Rs. 106 per dollar. The foreign liability stood at a relatively lower Rs. 58,537.2 million as of April 2013, which equals US $ 552.2 million, again at Rs. 106 per dollar. The figures suggest that commercial banks have sufficient foreign assets to discharge foreign liability. It is highly unlikely that there will be a repeat of the 2002 Argentina banking crisis which partly occurred due to devaluation of the Peso.
Another important issue associated with weakening currency is that it makes government debt payment to foreign counterparts more costly. It increases the budget expenditure of government, as total value of debt payment in NPR increase. As on April 2013, direct external debt of government of Nepal stood at Rs. 1,236.2 million (US $ 14.13 million at the then exchange rate of 87.46. But the effect of rise in the value of debt in NPR is minimal, and does not disrupt the functioning of the market.
With the anticipated rise in interest rate to 2.5 percent in America, positive growth figure in Europe, and Indian policymakers’ dilemma in targeting inflation, currency value, or growth, it seems unlikely that the value our currency will bounce back in the near future. Policymakers should use this opportunity to promote exports by identifying the potential areas of advantage, providing the right incentives and instituting appropriate policies.
The author is a founder member of BibekSheel Nepali and graduate in Development Economics
harryshr@gmail.com
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