Rupee devaluation: Counterview
Let’s not be Scared of Inflation

Sashin Joshi
CEO, Nepal Industrial and Commercial Bank Ltd.

Analysis of 20 years’ inflation indices of India and Nepal clearly indicates almost unitary co-relation (not same rate of inflation but the difference is similar with a similar trend line) between the two countries with a slight lead-lag effect, i.e. when inflation rises in India it takes a few months before the impact is felt in Nepal and vice versa. Therefore, it can be expected that inflation in Nepal will also fall over the next few months with a fall in India seen recently, everything else remaining equal. With more than 80 percent of  Nepal’s international trade (official and unofficial) being with India, this is inevitable and expected. If NPR were to be devalued now, there would certainly be an immediate quantum jump in the rate of inflation in Nepal relative to the extent of the devaluation due to price corrections on the supply side. However, once the correction is made, my prognosis is that the correlation will be maintained going forward.      

The lower rate of interest in Nepal is partially to be blamed for the higher inflation rate in Nepal vis-a-vis that of India. The lower cost of money is fuelling credit growth in non-productive sectors and consumption despite the lacklustre economic growth, which in turn is helping increase money supply. In such a scenario, devaluation will have no impact on interest rates; it will rather fuel inflation further resulting in contraction of purchasing power, which is bound to make the lives of fixed income middle class more miserable as they will have to lower their living standards.

Money supply in absolute terms will increase further with devaluation. Please also refer to the above. 

GDP growth in Nepal is estimated to be sub-3% in the current year as compared to plus 8% in India. Growth in GDP in the current scenario is possible only with an increase in capital expenditure, increase in production, increase in employment, increase in trade and increase in consumption. Devaluation will have a squeezing effect on all aspects mentioned unless massive external capital can be injected to fund capital expenditure and increased production capacity. There may be some benefit in the case of increasing the competitiveness of our exporters but since (1) almost all inputs of the majority of our export products are imported and (b) the share of export in our GDP is negligible, the beneficial impact will be negligible. 

We have adequate foreign exchange reserves to cover about 10 months’ import of goods and services. This is high by any standard. In view of our traditionally deficit trade account and surplus in current account, which is marginal (and in declining trend), devaluation could result in depletion in foreign currency reserves further over time in view of our high trade deficit unless there are compensating external capital inflows, everything else remaining the same. 

Devaluation will further widen the trade gap with India as we are so import dependant with Nepali exportable products likely to reduce further over the next few years as India liberalizes imports further (as it has been doing gradually), thereby, eliminating the duty arbitrage, which is the only reason why the export of the majority Nepali products to India is feasible. 

In view of the high trade dependency on India (some estimates put it at as high as 90%), the argument of subsidizing imports/undercutting exports is not tenable. As far as trade is concerned,  Nepal is joined at the hips with India (from our perspective); therefore, it’s almost like one economy and it’s better for India to subsidize us than for us to be a basket case. In fact, it might even be a good idea to move towards a unitary currency to eliminate such artificial barriers.

Lastly, devaluation will have such a debilitating adverse impact on the purchasing power of the Nepali citizens in the midst of all this uncertainty and lacklustre economic performance that I would not discount severe economic hardship for our people which may lead to another round of social and political problems when we are on the way to resolving.

Cheaper Dollar Means lower Cost of Industrial Raw Material

Sujit Mundul
CEO, Standard Chartered Bank Nepal Ltd.

Nepali Rupee is a partially convertible currency and pegged with Indian Rupees (1 INR = NPR 1.60 NPR). The present parity with Indian rupee was fixed in 1993.

Due to the fixed parity with INR, Nepali Rupee continued to gain against USD and has appreciated by more than 15 percent during the past six months, in line with the sharp appreciation of INR against the greenback . The Indian rupee’s gain is propelled by strong capital inflow and money market tightness, policy rate hikes and changes in the funding of current account deficit in India, making it Asia’s one of the best performing currencies.

Nepali economy at present is very fragile owing to longstanding internal conflict and political instability in the country for the past 10 years. The average GDP growth in the past four years remained at ~ 2%. In contrast to the same, Indian economy is performing well in recent years and has witnessed significant economic growth of 8-9% consistently over the years. India has been adopting managed floating system and moving ahead gradually towards capital account convertibility.

We can consider the issue as debatable on whether we should continue our fixed parity with India at the current level or we need to devalue our currency.

We, however are of the view that the Nepali rupee appreciation along with some fiscal tightening measures would be the best bet for the current government at this point in time, though it may have some adverse impact on export prospects. An appreciation of currency helps increase the supply of goods and services domestically by making imports cheaper. This in turn would help to curb inflationary pressures.

Nepal ’s exchange rate policy is influenced by trade dependency, economic and cultural proximity and porous border with India. Similarly, preferential trade treaty, and free convertibility of Indian rupee at a fixed rate reflects that the economic relationship with India is highly sensitive. At present, as per the official data, about 70% of the country’s total trade volume is with India. The high dependency with India for trade is expected to continue in the short to medium term due to more integration of trade with India in coming years. Hence the fixed parity with Indian Rupees has definitely helped us in maintaining exchange rate stability and would have positive impact on Nepali economy.

The majority of local manufacturing industries/exporters including carpet, garment, Pashmina, vegetable ghee etc. are entirely dependent on imported raw material. Generally the imports are against USD. Cheaper dollar means low cost of raw materials and low cost of production for Nepali exporters. Therefore the argument that the exporters are losing their competitive edge in the international market only due to appreciation of rupees is not fully justified. Yes, there could be some impact on their business prospects which can be well protected by government by other incentives such as duty drawback facility, rebate on export duty etc.

Decision to devalue the currency by changing the current peg with INR will have direct impact on petroleum price in the country. This will have multiplier effect and the inflation is expected to easily shoot up to unacceptable level from the current 7-8 percent. We do not expect the current economic condition of Nepal to sustain the same.

We therefore are of the view that our exchange rate policy should continue to remain geared towards maintaining the current level of peg with Indian rupees because the fixed parity with India has served Nepal well given the core dependency with India. Moreover, the current level of peg is appropriate for the reasons discussed above.

Conflicting Economic & Political Realities

Suman Joshi
CEO, Laxmi Bank Ltd.

Market and economic factors suggest that NPR should be devalued vis-a-vis INR. But current socio-economic ground realities make it disastrous to attempt a significant change in NPR/INR peg. Reasons:

• Inflation will rise further given our significant dependence on imports.

• Currency support alone is unlikely to revive export industries unless we develop comparative advantages and efficiencies. Our export base is already very small anyway.

• Our economy is practically married to that of India and an aggressive independent streak will create anomalies which we are incapable of addressing in the current scenario of chaos and uncertainties.

 All said, a decision to devalue NPR has political connotations as well and I personally do not expect the current regime to get there. For example, we are letting a state enterprise bleed and people face hardship for lack of political courage and consensus to review petroleum prices. It is our misfortune that in this day and age, our economy is still driven by politics rather than vice versa. I’ll be happy if my assumption is wrong here.

Nepal 's Inflation not Significantly Different from India's

K B Manandhar
Deputy Governor, Nepal Rastra Bank

Inflation in Nepal looks higher than in India. This is due to the fact that in Nepal we use consumer price index for calculating inflation and India they use wholesale price index. It is a well known fact that consumer price index always and everywhere will be higher than the wholesale price index. This particular fact has been well explained in The Economist magazine in its June 9, 2007 issue. So, once we take into consideration the open border between our two countries and the system of fixed exchange rates as well as the unlimited convertibility of Indian Rupee in Nepal, apparently, there is no reason why the inflation rate should be significantly different between India and Nepal.

Yes interest rate is much lower in Nepal. This basically reflects the boom being experienced in the Indian economy and the sluggishness in the Nepali economy. When there is such a large difference between the growth rates of the two countries, such differences in the interest rates is not unnatural. One additional factor responsible for this phenomenon is the fact that in India demand for credit is growing by some 30 per cent while the deposit is growing by some 16 per cent.

Conceptually, there is no direct relationship between the Money Supply growth and the need for either appreciation or depreciation of the exchange rate.

Yes, the forex reserve in Nepal is growing at slower pace than in India. This is a fact and the factors responsible for this are too apparent. The main factor responsible for this is the high capital inflows being recorded in India. On the one hand foreigners are pouring money into India and domestic entities in India are borrowing huge money from external sources.

Nepal has never enjoyed trade surplus either with India or with the rest of the world. But the important question here is not the volume of deficit, but the sustainability of such deficit. Looking into the Balance of Payment surplus situation and the country's foreign exchange reserves we need not worry about the deficit volume.

So, the overall comment is:

Yes Nepali Rupee is appreciating in terms of convertible currencies. Normally when we have that type of appreciation, it is followed by pressure in the Balance of Payment. This is reflected in the fall in the foreign exchange reserves of the country. But this has not happened in Nepal. Foreign exchange reserves of the country is increasing. There has been no decline in the foreign exchange which commercial banks has been selling to the central bank. Remittance flows into the country has not declined. The decline is not in the volume but in the growth rate. The high growth rates which were recorded in the past, can not be expected to continue for ever and this is what is happening right now.

So looking into all these factors, there is no need to have a policy turn around.