Do Not Rush Into De-pegging

In the changed scenario on the political front, many things are swirling around, one of them being the removal of the NPR-INR peg. The Nepali rupee (NPR) has been pegged to the Indian rupee (INR) since 1960 AD. At the time, confidence in the NPR was wobbly and was pegged to the INR at 1.6 to bring stability to the NPR. The pegging rate was revised multiple times in response to balance of payments stress and exchange rate misalignments. Coincidentally, the pegging came back to stay put at 1.6 in 1993. In between, the government experimented with multi-currency pegging and gold, and a trade-weighted basket of currencies. But these approaches proved to be unsustainable.

The manifesto of the Rastriya Swatantra Party (RSP) mentioned that the NPR-INR peg would be reviewed. Based on this, some people think that the NPR-INR peg should be removed as it interferes with the country’s monetary policy, depriving the country of economic sovereignty and monetary autonomy. With monetary autonomy, the country can set its own interest rates as per its economic conditions. Now, the country has to consider India’s monetary policy. With the removal of the peg, the country will be able to go about transactions in a more competitive way. This will enable the country to boost production, productivity and exports.

Trade

Their surmise is based on the NPR being stronger after de-pegging the currency from the INR. It is not necessary that the NPR will be stronger against the INR after the de-pegging. Rather, the NPR may, in all probability, depreciate against the INR. This will give rise to high inflation, with the prices of goods and services soaring to the disadvantage of poor and marginalised communities.

The country conducts two-thirds of its trade with India. The country has been suffering trade deficits for many years. The trade deficit with India alone is around sixty per cent of the total trade deficit. The country is basically dependent on India and other countries for essential goods such as raw materials, drugs, fuel, equipment and spare parts. On the other hand, the export sector is not robust enough to bridge the gap between imports and exports. As most of the trade is carried out with India, there is stability in the trade sector in monetary terms. Further, the country also receives a large amount of remittance money from India at a steady rate. With the NPR-INR peg in place, prices of goods and services are predictable and trade is running smoothly.

The country’s forex market is not robust. The NPR rate is steady against the INR but not against other currencies such as the USD, Euro, GBP, AUD, CAD and JPY. These rates are not determined by demand and supply in the domestic forex market. In fact, they are derived rates. As the NPR is pegged to the INR, the INR-USD rate and cross rates are taken as a base and the NPR is calculated against other currencies. This shows that the country cannot independently calibrate the NPR against other currencies. The country is not only dependent on India for goods and services but also for the calibration of foreign currencies, as there is no floating market in the country.

If there were no NPR-INR peg, the value of the NPR would be determined by demand and supply in the global currency market. Such a rate would be unpredictable. A depreciated NPR would make imports expensive, affecting the daily lives of poor people. The country has a huge external debt in foreign and Indian currencies. A weakened NPR would make the country ill-equipped to afford the debt servicing. It is not plausible that the country can make the NPR stronger against the INR after the de-pegging. In the past, the country tried to fix the NPR at 101 to 100 INR. This action on the part of the country drew strong revulsion from India, so much so that the action had to be withdrawn. This disrupted trade, delaying shipments of goods, breaching contracts and sending prices soaring, all to the disadvantage of the country.

The country is becoming a developing country in November of this year. The country has planned to be a middle-income country by 2030. For this, it is imperative to strengthen the economy by making reforms in various sectors. The country is making headway in hydropower development. However, other sectors are not looking up. The agricultural and industrial sectors leave much to be desired, although there are government policies towards revamping the sectors. The tourism sector is not satisfactory, either. Just wooing around 1.2 million foreign tourists annually is not enough, given the multiple tourist-attracting features the country boasts. The country is emphasising infrastructure development, but the tangible outcomes are yet to emerge.

Structural reforms

Getting rid of the shackles of the NPR-INR peg is a good thing, but the country should make structural reforms first. The export base should be made robust by accentuating import substitution. For this, agriculture, industry, tourism, and other economic sectors should be given a shot in the arm. The country should develop a strong forex market. The forex reserves the country has are limited from a global perspective. The country should have access to global markets and be able to show trade competitiveness. Without strengthening the economy, de-pegging the NPR from the INR would be suicidal.

The new government is full of energetic youth leaders, some of whom are young Turks. They intend to reform the governance system by taking harsh measures against corruption and other anomalies. At the same time, they should also pay heed to developing infrastructure and reforming the economy. With a robust economy in place, it would be appropriate to de-peg the NPR from the INR to establish the country’s own monetary identity in the global forex market.

(Maharjan has been regularly writing on contemporary issues for this daily since 2000.)