Falling NRP or Rising USD?

Neither really! The Nepalese rupees in comparison to the US dollars, has considerable weakened in the past 6 months. At the beginning of this year, the exchange rate was around 86-87 NPR per USD. The exchange rate was somewhat constant, with only minor fluctuations, from January till May. Come May, the exchange rate starts shooting up from a low of about 86 NPR/UDS to nearly 107NPR/USD in early September. That’s the highest NPR/USD exchange rate ever! In addition to that, the rate of increase is also quite surprising. The exchange rate seems to have increased around 24% in less than five months.

The rates have somewhat dropped and seem to be fluctuating between 98NPR/USD and 100NPR/USD this month. However, it is no surprise that the recent spike has caused some alarm and raised some concerns. Rising interest rates might spell trouble for some but could be opportunities for other. For others it could be merely a point of interest, and for others still it could irrelevant. Those that are directly affected by it are likely to be more familiar with the ongoing that affect our exchange rate than those for whom it is merely a footnote in their daily lives.

My purpose in this short post is to merely clarify a few things regarding our exchange rate. Firstly, our foreign exchange rate is directly linked to Indian foreign exchange rate. To understand anything about our exchange rate under this fixed pegged regime, we have to first understand the relationship between INR and other foreign currencies. Secondly, a weak rupee is not necessarily bad news, at least not to everybody. Even though exchange rate affects, to some degree, everyone in the economy, various interest groups are affected in various ways. Thirdly, I wish to stir some thoughts on the vulnerability such fixed pegged system can have on our economy as a whole.

Exchange rate regime is an important element of every economy, and it affects everyone living in that economy. Those in the import oriented industries, for example, are likely to be adversely affected by a weak NPR as their cost of goods will increase. Whereas those in the export oriented industry are likely to benefit from a weak NPR as their goods become effectively cheaper in the export countries. But as I mentioned above, even those of us that don’t have to deal with exchange rates directly are going to be affected by it indirectly via factors such as inflation/deflation, interest rates changes,  economic growth, and employment to name a few.

One factor that is particularly pertinent to an economy like ours is the impact of exchange rate on remittance. The weaker NRP gets, the greater the inflow of remittance. Inversely, the stronger NPR gets, the lower the inflow of remittance. Being a remittance based economy, the impact of exchange rate on remittance might be one of the factors to consider when assessing the impact of changes in exchange rate on Nepal’s economy.

Though the impact of fluctuations in the exchange rates is difficult to access, the determinants of our exchange rate are fairly simple to understand. Our exchange rate regime is pegged to the Indian Rupees at 1.6 NRP = 1 INR. What that means is the exchange rate of NRP with all other currency is directly the cause the exchange rate of INR with those currencies. The central bank of Nepal (Nepal Rastra Bank) intervenes in the Foreign Exchange market to control the fluctuations in demand and supply of NRP so as to keep it constantly pegged at 1.6 NRP/INR.

The recent rise in exchange rate can be understood by looking at the fall of INR relative to other currencies.  The fall in INR relative to USD can be credited to three major things: Worry of fall in liquidity in the US economy through Federal Reserve scaling back stimulus measures; Growing current account deficit that is coupled by increase in oil prices (India imports 80% of its oil); and falling investor’s confidence due to decreasing growth rate and punitive measures (initial) to address current account deficit. A detailed explanation on this can be found in http://www.bbc.co.uk/news/business-23860458 and http://profit.ndtv.com/news/forex/article-why-the-rupee-might-reach-70-against-dollar-326228.

What all this means to those of us in Nepal is that, if India fails to gain confidence of foreign investors, our importers will get hurt due to falling NPR. If oil prices drop and India is able to reduce its current account deficit, the remittance inflow in Nepal will fall thus reducing a key source income for so many of us. If the Federal Reserve scales back on its stimulus measures, the rate of job creation here is likely to decrease. The first two statements show how our livelihood is dependent on India’s performance and the last statement suggests how we are globally dependent on each other. Is this interdependence to our favour, or should we rather be independent of our monetary policies?

 

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