A thriving currency black market drags the fixed INR-NPR exchange rate into the debate again

The INR 100 currency note now selling for as high as NPR 180 in border towns of the Tarai has once more sparked debate in Nepal about whether the 55-year-old fixed peg with the Indian rupee needs revision.

With fuel, food and essentials being smuggled through the open border to be sold in the black market, there is also a thriving informal trade in Indian currency. Petrol smugglers need to be paid in INR and this demand has hiked the price of Indian currency which has been historically pegged to the Nepali rupee.

Some economists think that the black market rate for INR may reflect the true value of NPR, and that the exchange rate fixed at 1:1.6 more than two decades ago may need to be adjusted.

“The peg we have now is a political exchange rate, not an economic one,” says Sujeev Shakya of the think tank, Nepal Economic Forum. “The peg might have made sense 20 years ago, but is it still economically rational?”

The growing trade imbalance with India has meant that Nepal has a shortage of INR which it covers by selling the USD that it earns mainly from remittances of Nepali migrant workers abroad. Nepal’s foreign exchange reserves total nearly Rs 900 billion, enough to pay for nearly two years of imports.

“If the Indian rupee is unpegged, the Nepali rupee is not going into free fall,” one leading industrialist told Nepali Times this week, “we can easily buy Indian rupee in the international market by selling US dollars.”

But the reserves may not always be as comfortable. Countries that host Nepali migrant workers, including Gulf nations and Malaysia, are now seeing sluggish growth and political instability. This could affect remittance inflows.

But for the moment the problem with the INR peg is that it is looking increasingly unsustainable, especially after the Indian blockade. Experts say rather than unpegging the two rupees, what may need to be done is adjust the peg to a more realistic level, say 1:1.8.

Even before the current crisis, the fixed exchange rate meant Nepal had to implement monetary policies in line with those of India. However, while India has emphasised reducing inflation, Nepal’s inflation rate continues to spiral as a result of the April earthquake and the Madhes unrest.

This has reduced Nepal’s competitiveness. A recently-released report of the International Monetary Fund (IMF) also hints that Nepal has not been focused on ‘competitiveness-enhancing structural reforms to support the peg’.

But adjusting the exchange rate will not be without problems. Devaluing the NPR would make our exports cheaper on the international market. But since Nepal is so import-dependent on India, devaluation will lead to serious inflation. The other alternative, revaluation, was completely ruled out by a Nepal Rastra Bank official because of its potential to worsen the current account deficit.

Most economists have maintained that the peg has cushioned Nepal from our weak economy, and a revision should be made only when we have the required tools to handle the changed circumstances.

“The past twenty years or so have been politically turbulent, but Nepalis have never lost faith in our rupee because of the peg,” says Anil Shah, CEO of Mega Bank. “Let’s not fall for pseudo-nationalism. The last thing Nepal needs is a revision of the peg. I have more faith in the peg than in the government.”

Bhuwan Dahal, CEO of Sanima Bank, agrees. “The Nepali rupee may be overvalued and may need to change, but this is not the right time,” he says. In its report, the IMF also concludes that ‘the peg continues to benefit Nepal in view of its close economic relationship with India’.

What all experts – supporters and critics – agree on is that there must be a mechanism, both in the government and in the private sector, to review the peg at stated intervals.

Says Shakya: “The peg may be right, it may be wrong, but somebody needs to research its costs and benefits and come up with a conclusion. It has been 22 years since it was fixed at 160.”

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