Nepal has been maintaining a fixed pegged exchange rate of 1.6 with India since early 90s and was done with logical analysis after considering all the socio-economic, political and geographical conditions then. The peg has been changed several times before that as per the situation of the country.
Now the question here arises: Is it the right time to talk about peg change?
First, we need to understand why we are bound to have our exchange rate pegged with Indian currency? We have no option left but to have a fixed peg with India as we share an open border and a similar social structure. Furthermore, we have a huge trade dependency with them.
Now the other question that arises is if the present fixed peg of 1.6 is adequate and also whether it is the right time to talk about possible change in the peg? It is true that Nepali rupee is strengthening because we have a fixed peg to Indian currency and it has been strong against other foreign currencies because of encouraging economic growth rate of India. Despite having economic growth that is less than half of that of India’s, Nepali currency is still appreciating, which obviously is not fair.
NRB Governor Dr Yuva Raj Khatiwada has pressed a panic button by talking about changing currency peg. Instead of doing that, he should have taken some measures to increase the economic health of the country.
One of the major factors for pegging the rate is our trade dependency with India. Imports from India have increased marginally widening the balance of payment (BoP) gap. As of latest data provided by Nepal Rastra Bank (NRB), our BoP stood negative by Nepali rupees 23.53 billion, which means pegged rate with India is necessary in order to keep our price level stable, though we are facing double-digit inflation since the last few years. Another reason for peg is open border and cultural similarity with India.
Now, let us consider a few points, which make a case for opposing the change in the peg rate.
REMITTANCES & FOREIGN EXCHANGE RESERVES
Nepal has now become a remittance-based economy. Foreign remittance is equivalent to 21 percent of total Gross Domestic Product of the country. It has also been the major source of our foreign exchange reserves. It is true that due to global financial crisis, many remittance-based countries had difficulty due to declining trend of remittance inflows. Nepal has also been affected a little due to this financial crisis. However, remittance has always been in the increasing trend, though the rate of increment of remittance decreased a little last year. However, Nepali workers going abroad for work especially in the Middle East and Malaysia are increasing. Remittance from India is also substantial but it does not enter the country through the banking channel. As per latest data revealed by NRB, the gross foreign exchange reserves dropped by 15.6 percent to 236.34 billion rupees in mid-March 2010. The current level of reserves is sufficient for financing merchandise imports of 7.6 months and merchandise and service imports of 6.6 months. Devaluation in currency peg should be thought of only in case the reserves of the country declines to a level where our reserves would be sufficient to support imports of only a month.
UNSTABLE POLITICAL SITUATION
This is definitely not the best time to think of changing the currency peg, which in itself is a very sensitive issue at current unstable political situation. Chaotic political environment has been a major contributor for uncertain and declining economic situation of the country. There is also smell of money flying out of Nepal due to uncertainty. In such a condition, if peg change is brought about, even more dangerous situation is likely to occur. For example, if peg rate is changed to 1.80, value of a US Dollar will be around Nepali currency 84. As we are an import-based country, if the peg is changed, the increase in price level of the country would tremendously hurt the people.
When is it suitable to go for peg change? Peg change can definitely be considered when relatively stable political environment is established. Formation of constitution is must for this. When the constitution is formed, it can be believed that Nepal will be able to get a direction for the economy, most likely toward a positive direction. It can also be expected that current level of trade deficit will also be minimized to some extent leading to even better foreign exchange reserves.
I strongly believe that a person such as the central bank governor should not have given such a statement on such a serious issue without holding discussions within the country. The matter first requires to be analyzed and discussed at working levels as well as policy levels of the country.
This statement is likely to increase the unnecessary holding of Indian currency, which is happening at the border areas at present. Rather than making such a comment, he should have focused on making policies and environment in order to minimize the trade gap by reducing imports, especially unproductive sector imports. Remittance inflows should be utilized in development of the productive sectors. Governor Khatiwada has pressed a panic button by talking about such a critical and sensitive issue at such a wrong time. Instead of doing that, he should have taken some measures to increase the economic health of the country.
(Writer is Chief Operating Officer, Citizens Bank International Ltd.)
rajunepal@gmail.com
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