Nepal’s external position strengthens despite persistent trade deficit

KATHMANDU: Nepal’s foreign currency reserves have climbed to historic high, underpinned by a sharp balance-of-payments (BoP) surplus that has significantly strengthened the country’s external sector at a time of subdued imports and resilient foreign inflows.

According to the latest report of Nepal Rastra Bank (NRB), the overall BoP surplus reached Rs 421.9 billion, pushing gross foreign-exchange reserves to Rs 3.2 trillion, equivalent to USD 22.1 billion. The current reserve level is sufficient to finance 18.2 months of merchandise and services imports, the highest import cover ratio in South Asia and among the strongest in the broader region.

The central bank said foreign-exchange reserves have increased by 19.6 percent since mid-July alone, reflecting a combination of higher remittance inflows, lower import bills, steady tourism receipts, and restrained capital outflows. The rapid accumulation of reserves has been so strong that NRB has had to intervene aggressively in the foreign-exchange market to prevent excessive appreciation pressure on the Nepali rupee.

Over the review period, the central bank mopped up foreign currency worth Rs 410 billion through open-market operations, primarily purchasing US dollars from the market. This intervention was aimed at stabilizing the exchange rate as the US dollar weakened globally and excess dollar liquidity built up domestically.

Why Foreign Currency Reserves Matter

Foreign currency reserves are a critical buffer for Nepal’s economy, particularly given its heavy dependence on imports for fuel, machinery, medicine, food items, and industrial raw materials. Adequate reserves allow the country to pay for essential imports, service external debt, and manage external shocks such as commodity price spikes, global financial volatility, or sudden declines in remittance inflows.

For a country like Nepal, which operates a managed exchange rate regime with the Nepali rupee pegged to the Indian rupee, strong reserves also enhance confidence in the currency peg and overall macroeconomic stability. Economists note that high reserve adequacy reassures investors, credit rating agencies, and development partners about Nepal’s ability to meet its external obligations.

NRB officials say the current reserve position provides substantial policy space to manage volatility in trade flows and capital movements, while also supporting financial sector stability.

Use of Reserves and Monetary Management

While reserves strengthen external security, they also pose policy challenges. Excessive reserve accumulation can inject surplus liquidity into the domestic financial system, complicating monetary management. To address this, NRB has been actively sterilizing inflows through open-market operations, including deposit auctions and foreign-exchange absorption, to control excess liquidity and inflationary pressures.

The central bank has emphasized that reserves are not meant for routine fiscal spending but are strategic assets used to stabilize the economy during periods of stress, ensure smooth foreign trade settlements, and support balance-of-payments management.

Foreign Trade Scenario Behind the Surge

Nepal’s foreign trade dynamics remain structurally imbalanced, with imports far exceeding exports. However, the current surge in reserves is largely driven by a contraction in imports amid weak domestic demand and tighter credit conditions, while exports have shown only marginal improvement.

Merchandise exports continue to face competitiveness challenges, including high production costs, logistics bottlenecks, and limited product diversification. As a result, remittances remain the single largest source of foreign currency inflows, effectively financing the trade deficit.

Tourism receipts have also contributed positively as international arrivals recover, adding to services exports and helping narrow the current account gap.

Sustainability Concerns

Economists caution that while the current reserve position is exceptionally strong, sustainability depends on reviving domestic investment, expanding exports, and reducing structural dependence on remittances. A prolonged import slowdown, they warn, may reflect weak economic activity rather than genuine external sector strength.

Still, NRB maintains that Nepal’s external position is currently comfortable, providing a rare window of stability for policymakers to pursue structural reforms in trade, production, and investment aimed at strengthening long-term foreign exchange earnings.