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8/17/2017

Fixed @1.6: We don’t desire it, but we can’t remain without! | My management and economics blog

@1.6: We don’t desire it, but we can’t remain without!

There has been considerable pressure on governments and the central bank of Nepal to reconsider the traditional rate system of 1 INR equaling to 1.6 Nepalese rupees. In some extreme instances, there are voices heard in support of entirely changing the exchange rate module and shift to some other form. Nepal has been following the pegged rate of 1 INR = 1.6 NRS since the past two decade, from 1993 to be precise. Time and again the debate looms over at the policy and political level on whether it is time to reconsider the seemingly obsolete framework that has been in existence. Despite voices and arguments, it is has been rooted at a constant rate. Exchange rate is the most sensitive tool change in which has widespread and instant impact seen on every aspect of the economy-from small house hold to giant manufacturers and traders. Before considering changes policymakers must consider the implications of those changes upon the economy. The questions that that will help unravel the dynamics of exchange rate are: why is Nepal bound to stay fixed at 1.6? How feasible is it feasible for Nepal to change? What factors affect in determining the rates and what can be the consequences if in case there is any changes made in the pegged rate.

Certainly, the propositions put by those who think Nepal should reconsider devaluing its exchange rate from 1.6 to

and so on) is valid. Due to this overvalued exchange rate, Nepal’s export growth potential has

been hindered as it cannot compete in international market. This has proved to be significantly counterproductive in the case of trade with Indian market. Devaluation of exchange rate alone is sure to increase exports, and reduce the demand for imports inside Nepal itself. According to the IMF assessment, Nepal’s currency is overvalued by 9% (IMF Country Report 2012). It means that the exports of Nepali products are costlier by round about the same overvalued percentage compared against the country which currency undervalued or at a balanced level.

lower value (1.7, 1.75

Likewise, fixing Nepali currency means importing inflation home. Due to poor structural measures to control inflation the already high inflation rate gets amplified by the time it dilutes in the market. Beside the aspect of trade and export there are several other issues which make serious questions regarding this currency rate valuation of Nepal. The current model had been made at a time when Nepal’s economy had different outlook and attributes. Much has changed since the last time currency fixation in Nepal was carried. Balance of payment deficit is ever soaring. Nepal has made its presence in the world arena with its accession into the WTO. Likewise, trade, export, foreign investment, local investment, regional trade openings, identification of key products of competence etc are making priorities today; at least in papers if not at the execution level.

At first sight it is almost inevitable for a country to opt for a lower value of its currency with respect to the pegged one. The theory of trade and country competence supports the assumption that a lower valued currency is comparably cheaper than the higher valued currency. Numerical demonstration can be used to put in light some of the advantages which a lower valued currency can bring to our economy. Let’s suppose that the cost of a Nepali commodity sold in India is Nrs 160. At the prevailing rate, it will cost an Indian buyer Rs 100 at the market price. In the case of changing the currency exchange rate to 1.7 the same commodity can be bought by the Indian buyer at INR 94.11. Lower the denomination, cheaper the exported product and hence higher the national export will be. This will hold true even for the rest of the world buyers. Conversely, the same will make imported goods costlier for Nepali consumers. For

8/17/2017

Fixed @1.6: We don’t desire it, but we can’t remain without! | My management and economics blog

instance, a product costing Rs.160 in Nepal will now cost Rs. 170. Given the tremendous dependence of Nepal upon India, it is certain to lead to unimaginable inflation in every sector of the economy.

The vicious cycle

There are contradictions between National trade policies at various levels and in the exchange rate value of Nepal. Trade policies emphasize on creating conducive environment for trade and making the products competitive in the international market. However, due to currency overvaluation export enhancement is unlikely to happen for Nepal. Other thing to consider is that pegging at certain rate by Nepal is providing unfair advantage to Indian products i.e. due to huge fluctuation in dollar rates foreign products are unable to compete against Indian products because the rates between Nepal and India remains unaffected as it is fixed at 1.6. This has also compelled Nepalese buyers to consume more of Indian goods and traders feel more secure to trade with India rather than with rest of the world.

to trade with India rather than with rest of the world.

Nepal like any other sovereign nation has the right to determine its exchange system and rates. One must understand that Nepal is not forced by anyone but only by the prevailing National situation. Surprisingly it may seem to be, Nepal does not have the luxury to play with the exchange rate denomination. It is simply because of the volume of trade between Nepal and India that is responsible. Nepal owes a huge proportion of its import to India while the export figures to India remain dismal. Even if Nepal chooses to devalue its currency, the extreme level of Indian export will lead to unimaginable inflation which Nepal’s economy cannot support i.e. goods ranging from salt to steel will see a price hike which means that every segment will be adversely affected. Every item purchased will become expensive by the same factor Nepal chooses to depreciate i.e. the item costing INR 100 which was costing 160 for Nepali consumers will now cost RS. 170 if devalued at 1.7 per Indian rupee. Further, the cost of production will go up which will again lead to the making Nepal made products expensive. This will have much bigger impact on Nepalese economy and will simply undo for the benefits that Nepal may be getting from growth in export.

8/17/2017

Fixed @1.6: We don’t desire it, but we can’t remain without! | My management and economics blog

can’t remain without! | My management and economics blog [http://4.bp.blogspot.com/-

There has been a constant struggle to get Nepal out of the bottleneck that exchange rate has induced. It will take effort of huge magnitude for Nepal to get out of this situation. Only way to do so is to diversify export to other country and decrease the dependence with India. Nepal must seek to get maximum benefit from the regional and world trade associations and agreements and set itself a platform to sell its product to other countries. Similarly, another way is to enhance internal consumption of local product and substitute Indian imports. This again can be done only through massive industrialization efforts. Given the political stalemate and worsening labor problem makes it difficult to come up with high volume industrial set-up in Nepal. Efforts to bring in FDIs must be accelerated to bring in capital for production and infrastructural frameworks. The rise in entrepreneurial ventures and budding small and medium level enterprises has given glimmer of hope on Nepal coming with competent products. For now, the pegged rate continues to provide a widely visible nominal anchor and support macroeconomic stability for Nepal. Adjusting the peg may curb imports, but the following consequences bring more harm than good for the economy most visibly in the form of inflation.

Posted 27th May 2013 by raghav pokharel

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