The peg of Nepali rupee to the Indian rupee has its benefits. Two-thirds of Nepal’s foreign trade is with the southern neighbor and a fluctuating rate would make the Nepali currency amenable to wild swings even on the news of modest changes in the Indian economy. Currency speculation would go on an overdrive and the open border and informal exchanges would soon suck the Nepali economy dry.
But there is also a big downside. When the going gets tough for the Indian rupee on the international exchange market, the Nepali currency also takes a pummeling. Nepali rupee traded at 103.50 per dollar on Friday, continuing on its dangerous downfall in the last few months. This was after the Indian rupee hit an all-time low of 65.04 to the dollar on Thursday. [break]
The decline in the value of the Indian currency has been attributed to the American government’s decision to cut back on pumping money into the market on the back of some good news on the American economy. As the US economy recovers, the dollar will continue to gain in strength and with the gradual pullback of the much-touched quantitative easing, there is likely to be less money going out of the country to economic hotspots like India. Hence the scramble of foreign investors out of India and growing demand for US dollar.
Nepal as such can do very little on its own to stabilize its currency against the dollar, let alone reverse the alarming decline. It is in no position to remove the peg with the Indian rupee and even if it is removed, there is no guarantee that the Nepali rupee would halt its slide against the greenback. A decline in the value of currency is a mixed blessing.
While it stokes inflation (and the rate of inflation in Nepal is already in double digit), it can also boost exports by making local goods cheaper. But years of political instability and poor infrastructure (most vitally power) has left the country in no position to jack up exports. If anything, the trade deficit has been steadily widening, reaching a whopping Rs 479.82 billion in 2012-13, a 23.9 percent year-on-year increase. Meanwhile, inflation will continue to increase as third-country imports become more and more expensive and manufacturing costs soar.
The only meaningful way the country can gain from the depreciation of rupee against dollar is through an increase in the value of remittance (Rs 434.58 billion in 2012-13). But since nearly three-fourths of this money is spent on imported merchandize, ultimately, most of it will be siphoned out of the country. The economy has been badly exposed at this difficult juncture in the country’s history.
Galloping inflation could further destabilize an already unstable transitional economy and Nepal can do very little to resurrect the situation right now. The dangerous slide in the value of the Nepali rupee and the emerging risks send an unmistakable message that unless economic fundamentals are right, no amount of remittance can save the economy.
In the long run, the only way to stabilize the economy would be to revive moribund industries and boost exports of products like tea, carpets and herbs where Nepal enjoys competitive advantage. This in turn calls for better infrastructure, of which none is more important than electricity. For a country in transition, there is a close link between politics and economy. Unless there is genuine political commitment and a common political roadmap for economic (and hydropower) development, things are likely to get a lot worse before they get better. If the latest rupee scare does not make politicians see reason, perhaps nothing will.
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