Therefore, as soon as Nepal Rastra Bank (NRB), the central bank of the country, was established in 1956, it began to work on the modality of giving Nepali rupee the sole legal tender. It also tried to do away with the existing arrangement of dual-currency system in Nepal.
Accordingly, the dual currency system was abolished under Nepal Currency Circulation and Expansion Act in 1957. A new single currency regime was established in which Nepal Rastra Bank pegged the Nepali rupee to the Indian rupee and fixed the exchange rate of the Nepali rupees at 160 for Indian rupees 100. Such a provision entailed that NRB would buy and sell any amount of Indian rupees at the given exchange rate. So many exchange counters were opened in different parts of the country to provide this service. Also, the banking institutions in the country were authorized to facilitate the exchange of these currencies at the fixed exchange rate.
Significantly, on June 6, 1966, the Indian government substantially devalued its Indian currency. Nepal on its part had to do little as the Nepali rupee had already been pegged to the Indian rupee. But the end result was that the Nepali currency automatically got to be appreciated vis-a-vis the Indian currency on account of the pegging factor. As such, the new exchange rate between the two currencies was established at Nepali rupees 101 equivalent to Indian rupees 100.
The last adjustment that was made between the two currencies was on February 1, 1993, when again the old exchange rate of Nepali rupees 160 equivalent to Indian rupees 100 was revived. Thus, for quite a long time, the exchange rate between the Nepali and Indian rupees has been largely the same, despite the fact that the Foreign Exchange Regulation Act 1962 allowed convertibility of Nepali rupees with all other currencies.
But in certain quarters, the rationality of the pegging of Nepali rupee with the Indian rupee is questioned. An impression is created as if the pegging up the Nepali rupees with the Indian rupees is not in Nepal´s national interest. So, there have been several efforts made to remove this provision.
As it is well known, the only alternative arrangement of the pegged currency regime is the introduction of floating exchange rate system between the Nepali and Indian rupees. Under the floating exchange regime, exchange rate between the Nepali and Indian rupees would be determined each day on the basis of demand and supply of the respective currencies as it happens in relation to the exchange rate of Nepali currency with all other currencies, including Euro or US dollar.
But the central bank in Nepal does not dare to follow the floating exchange rate regime by doing away with the existing pegging up arrangement with the Indian currency, though it is all free to do that. It is feared that any attempt to introduce floating exchange rate regime between the Nepali and Indian currencies by fixing their rates on day-to-day basis would bring further instability in the Nepali economy.
Besides other things, this would further erode people’s confidence in the Nepali currency as well as in the banking and financial institutions. Already, people’s faith in such institutions is at the lowest ebb. This is the reason why many of the people do not like to deposit their money in the banks and financial institutions. As a result, severe liquidity problem has erupted among these institutions in the recent time.
On the other side of Nepal’s border, India has emerged as the world´s second-fastest growing economy with annual rate of economic growth of around 9 percent. In the international market, the value of Indian rupees is increasing due to the growing strength of the economy. But in Nepal the Nepali currency has gradually been loosing its value on account of the poor economic growth of 3.4 percent. If there were floating exchange rate arrangement between the Nepali and Indian rupees in the place of fixed exchange rate, the value of the Nepali currency would have been far lower than what is it is today.
Moreover, the floating exchange rate does not appear to be practical for Nepal as the central bank of the country is not fully equipped to run independent monetary policy for its own limitations. It can do very little to control inflation through its monetary policy. Until inflation is controlled in India, the central banking authority can do little about it in Nepal. Worse still, the central bank in the country has not been able to do anything concrete to check the shrinking base of the circulation of Nepali currency in the country.
Truly, the economic instability is kept within the sizeable limit as the Nepali rupee is pegged to the Indian rupee. Realizing this fact, Yuva Raj Khatiwada, governor of NRB said that the Nepali currency is strengthening just because it is pegged to the Indian currency. Khatiwada’s Indian counterpart, Duvvuri Subbarao, also said, “For now, we do not have any plan to adjust the exchange rate. It is possible if both Nepali and Indian governments feel necessary.”
In the existing situation, any effort to do away with our peg would further harm the Nepali economy. It will promote capital flight from the country and thereby affect business, trade and other economic activities. Besides, it would also bring about hyper inflation in the country. Hence, it will be mere waste of time and energy in giving a thought to dithering with the pegging arrangement between the Nepali and Indian currencies. There are more important things that the central bank and other institutions need to concentrate upon and that is to restore people’s confidence in the banking and financial institutions in order to ensure economic stability in the country, which has deteriorated to the worst level in recent times.
The Writer is a Professor of Economics
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