Chandan Sapkota’s Blog
This blog post looks at a few of the issues surrounding the pegged exchange rate between the Nepali rupee and Indian rupee, and its own impact on competitiveness. For earlier articles on the exchange rate, see these posts: Stay the course on the exchange rate; Q&A on exchange rate; self-confidence on the Indian rupee in Nepal;, and services exports’ competitiveness. Nepal has been keeping a pegged exchange rate to the Indian rupee for a long period.
NRs 1.60 was prevalent in FY1965 even. But, the Nepalese rupee has been revalued and devalued as per the evolving nature of Nepal’s and India’s economies. NRs 1.39). From October 9 Then effective, 1975, the exchange rate of the Nepalese rupee vis-a-vis the united states dollar was modified. The exchange rate of other convertible currencies was quoted daily with reference to the US dollar rate in the international money market. On June 1, 1983, the exchange-rate system pegged on US money and Indian money was replaced with a basket of currency system.
On July 1, 1991 the Nepalese rupee was revalued against Indian money by 1.8 percent. And, on March 4, 1992 the Nepalese rupee was made partially (65:35) convertible on current account. As mentioned earlier, the primary rationale for the demands the revision of the exchange rate, whether going for a fully versatile system or devaluing the exchange rate, is to thin down the widening trade deficit.
The prevailing understanding among some experts and policymakers is that the prevailing peg has to be devalued-a deliberate downward modification to the state exchange rate-so that Nepal’s export price competitiveness is improved and hence exports boosted. Rodrik (2008) demonstrated that undervaluation of currencies (i.e. a high real exchange rate) not only reduces the trade deficit, but stimulates financial growth in developing countries also.
The caveat of the finding is that the operative route is the tradeable sector (mainly industry), which should have a pretty strong foundation such that it can take advantage of the devaluation of exchange rate. Quite simply, developing countries that can increase the relative profitability of their tradables are most likely to attain higher growth from money devaluation.
Unfortunately, at present, Nepal doesn’t have a strong industrial base credited to prolonged structural constraints to economic activities (also see why is Nepal poor?). Though the existing economic fundamentals and widening of the trade deficit with India necessitate a devaluation of the exchange rate, it can only just work if Nepal has the prerequisites set up for the export-oriented areas to remove.
However, given the existing fluid politics situation, it is simpler said than done. Remember that hastily devaluing the exchange rate would risk adverse effect on the already deteriorating trade deficit because of the J-curve impact. In the brief run, a real devaluation may not necessarily reduce total import quantity as export and import cable connections are confirmed in advance.
It means that the worthiness of the current import volume would be higher in terms of domestic currency, leading to undesirable effect on the balance of trade. In the long run, as import quantity gets affected by increased relative prices, total imports might reduce. Hence, a real depreciation might cause more damage before the expected changes begin to kick in initially, that also provided that Nepal already gets the prerequisites for export-oriented areas to take off. A devaluation of the exchange rate will continue to work only if the prerequisites are set up and institutional and market failures taken care of. Caramazza, Francesco, and Jahangir Aziz.
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IMF. NEPAL Article IV Consultation. Sapkota, Chandan, and Adnan Kummer. Yagci, Fahrettin. SELECTION OF Exchange Rate Regimes For Developing Countries. Nepal initiated the Structural Adjustment Program. Technically devaluation of the exchange rate makes exports less costly and discourages imports, which could lessen both trade deficit and current account deficit. The assumption is that the price differential between Nepal and India are closely related to the relative price constructions in both economies. Furthermore, maintaining a devalued real exchange rate requires a higher saving in accordance with the investment, or lower expenses in accordance with income.
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