The fixed exchange rate since 1993 of INR 100 = NPR 160 has to go. It was/is a clear drag on Nepal’s economy – the elephant in the room ignored for political expediency and fear. Differences in relative costs of production of similar goods, including food, between India and Nepal have substantially eroded Nepal’s competitiveness. While NPR has depreciated against USD, it remained fixed with the currency of our main trading partner, boosting their exports and supressing our own exports to them.
A common view in Nepal is that when India exerts undue political pressure, it is because we invite it through the ineptness and missteps of our politicians. A similar conclusion applies to the fixed INR exchange rate of almost 30 years: we are essentially handing India the stick to keep bullying us economically as well.
One common measure of divergence in production costs (changes in the GDP deflator) shows Nepal’s cost base increased 5.8 times between 1993 and 2018, compared to 4.0 times in India. That higher increase in Nepal can be reset only with a significant devaluation against the INR. Many input costs will increase for Nepali producers with a devaluation, but so will the scope to increase value added from domestic production, by reducing imports and increasing exports.
Hopefully that is concentrated in the agriculture sector where Nepal’s competitiveness has diminished greatly in recent decades. The decline in real income for all consumers from price increases will, however, have to be compensated. Hence, a UBI.
Devaluations are disruptive, and an open border increases risk of speculative capital flight. So, it has to be planned and executed with great care, including devising clever ways to avoid being second-guessed by market players.
The partial economic shutdown, and the general disruption in trade flows and labour movements between Nepal and India, in particular, makes this a good time. Short-term disruptions are a necessary cost to bear for the medium-term benefits of devaluation, which will boost domestic production.
India itself is a good example of how a persistent currency depreciation substantially improved its world trade position since the 1991 reforms. It currently exports around 20% of its GDP. Surprisingly, Nepal is the 10th most important destination country for Indian exports. At around US$7 billion, Nepal accounts for slightly more than 2% of total Indian exports.
On the other hand, Nepal is number 62 in the rank of countries for India’s imports in 2019, accounting for less than 0.15% of India’s total imports, a minuscule share, even though India is the destination for around 66% of Nepal’s total exports. Hence, even a small increase in Nepal’s share in India’s total imports would be a big increase in Nepal’s total exports.
Whether the NPR should remain pegged to the INR after devaluation or other arrangements made is a separate secondary issue: critical need is to abandon the current fixed rate and devalue, and quickly.
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