A few bits of information and some reports on Indian Currency (INR) transactions are floating in the Nepali Market:
1. Reports that Reserve Bank of India (RBI) is inquiring Nepal on the huge demand of Indian Rupees in Nepali Market
2. Reports that RBI intends to conduct all its trade with Nepal in US Dollars and
3. Information that Nepal Rastra Bank (NRB) has not been able to adequately supply Indian Rupees to its banks which has resulted in an acute shortage of INR in the market.
As we are all aware, there is a huge shortage of Indian Currency in Nepali Market due to the inability of NRB to meet market’s demand of Indian Currency. It has now put in place some stringent measures regarding withdrawal and purchase of INR. Know Your Customer (KYC) regulations invoked by NRB while dealing with INR are also quite strict. However, the huge impact of unofficial black marketing of Indian Currency in border areas also can’t be denied. People are paying premium of about Rs. 2 or more in informal market to purchase INR 100. It is surprising that any volume of INR can be exchanged upon purchase-in-premium from these informal markets. This raises an important question: Is the shortage actually due to high demand of Indian Currency? If yes, what are the reasons for such a high demand?
Every day, thousands of people cross over from Nepal to India for multifold purposes like trading, holidaying, religious and spiritual travelling, medical treatment, studying and working. However, the reverse flow of people from India to Nepal is minimal; so are our exports to India which used to attract INR. This is one of the reasons for the current INR shortage. The more unofficial exports to India increase, the more INR will enter Nepal. But the shortage signifies that black market export from Nepal into India has declined drastically, thereby resulting in shortage of INR in Nepal.
According to latest NRB data, the central bank purchased Indian currency equivalent to Rs. 110.62 billion through the sale of US $1.42 billion in the Indian money market during the six months period of this fiscal year. INR equivalent to Rs. 88.89 billion was purchased through the sale of US $1.22 billion in the corresponding period of previous year.
During the last fiscal year, Nepal’s import from India made up two-thirds of its total imports. As per NRB, imports from India increased by 10.1 percent during the six months of this year, as compared to the same period the previous year.
Another factor could be capital flight from Nepal owing to its political uncertainty, which in turn has bred an equally uncertain economic climate in Nepal. It is also possible that speculators have started holding INR in huge volumes in order to benefit from change of the peg rate.
If the Indian central bank really intends to conduct all its transactions with Nepal in US dollars it’s a matter of great concern.
As we all know, Indian Rupee has been pegged with Nepali rupee at a rate of 1.6 since 1993, not surprising given Nepal’s overdependence on trade with India. This keeps our price level stable, even though we have been facing double digit inflation for the last few years. Another reason for fixed peg is open border and socio-cultural affiliation between the peoples of the two countries. In fact, there is no option to fixed peg under these circumstances.
In order to dampen the demand of INR, NRB has expanded the list of products that can be imported from India against US dollars. Similarly, there are reports that RBI has issued a circular to its banks to start trade transaction with Nepal in USD. (Previously, Nepal and Bhutan had been trading with India in INR.) The circular that only concerns Nepal clearly implies that India seeks to minimize frauds related to INR transactions in Nepal. But this will have an adverse effect on two-way trade in border areas.
This RBI inquiry could be one of the strategies of the Indian government to put pressure on Nepali government to change the peg. As an import-dependent land-locked country, Nepal has always been dependent on India, politically, economically and culturally. This could be one of India’s strategies to maintain Nepal’s monetary dependency on the southern neighbor. As Indian businesses in Nepal will not immediately benefit by a change in the peg, the latest move seems to have been taken with a long-term vision.
Yet, given that the coalition under Babubam Bhattarai could fall anytime, we are not in a position to change the peg. It is true that Nepali rupee is appreciating only because Indian rupee has been strong against other foreign currencies, largely because of India’s encouraging economic growth. But Nepal’s growth is less than half of India’s. This is unfair.
Now, let us focus on the consequences of an increase in the peg:
First, the rate of Nepali rupee against all the other currencies will increase as rates of other currencies are fixed as per cross rate of Nepali rupee with USD and rate of USD is fixed as per cross rate of Nepali Rupee with Indian Rupee. For example, if the peg rate is changed to 1.80, price of USD will reach around Rs. 100.
Second, in the wake of the prolonged shortage of petroleum products and at a time when Nepal Oil Corporation (NOC) has already twice hiked the price of petro-produces in the last two months, the prices might need to be revised upward again with the changed peg having a direct impact on Nepal’s import of petroleum products from India.
Third, since we are an import-dependent country, people will not be able to afford increased price level. In this context, inflation might reach unprecedented levels and Nepal could well be declared a failed state.
If the government does not come up with cogent answers to RBI’s inquiry, the outcome could be dangerous. People would unnecessarily start holding INR, a phenomena already witnessed in border areas. The general public will be forced to deal with speculators, leading to further scarcity of foreign currencies.
The government should thus explore ways to provide INR as per market demands. The other focus should be on cutting imports, especially imports into unproductive sectors.
The author is Chief Operating Officer at Citizens Bank International Limited. The views are personal.
rajunepal@rajunepal.com
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