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8/17/2017 Fixed @1.6: We dont desire it, but we cant remain without!

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27th May 2013 Fixed @1.6: We dont desire it, but we cant remain without!

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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
lower value (1.7, 1.75.. and so on) is valid. Due to this overvalued exchange rate, Nepals 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, Nepals 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.

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 Nepals 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. Lets 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
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8/17/2017 Fixed @1.6: We dont desire it, but we cant 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.

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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 Nepals 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.

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8/17/2017 Fixed @1.6: We dont desire it, but we cant remain without! | My management and economics blog

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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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