Calls grow to review Nepal’s currency peg with Indian Rupee; What will RSP government do?

KATHMANDU: Mounting evidence from international institutions and recent economic studies has intensified calls for Nepal to reconsider its long-standing fixed exchange rate regime with the Indian currency, raising critical policy questions for the incoming government led by the Rastriya Swatantra Party (RSP).

Nepal has maintained a fixed exchange rate of NPR 1.6 per Indian rupee since 1991—a policy credited with ensuring macroeconomic stability for over three decades. However, shifting economic fundamentals, rising inflation differentials, and weakening export competitiveness are now prompting policymakers and global institutions to push for a comprehensive review.

Growing Pressure from Global Institutions

Major development partners, including the World Bank and the International Monetary Fund, have increasingly flagged concerns about Nepal’s exchange rate dynamics. A 2023 report by the World Bank highlighted that Nepal’s real effective exchange rate (REER) has been rising—indicating that the Nepali currency is becoming overvalued in real terms.

This overvaluation, experts argue, is eroding Nepal’s export competitiveness, making its goods relatively more expensive in international markets.

Similarly, a recent monetary research publication by the Bank of Korea echoed the need for reassessment, adding to earlier recommendations made by Nepal’s own high-level economic reform advisory commission.

The Core Problem: Overvaluation Amid Inflation Divergence

While the Nepali rupee has depreciated against the US dollar in nominal terms, its value relative to the Indian rupee has effectively increased in real terms due to higher domestic inflation.

Historically, for nearly two decades after the peg was introduced, Nepal maintained slightly lower inflation than India—by about 0.1 percentage points annually. However, since 2015, Nepal’s inflation has exceeded India’s by around 1.1 percentage points on average.

This divergence has led to a situation where:

Nominal exchange rate remains fixed (1 INR = 1.6 NPR)
Real exchange rate appreciates (making Nepali goods less competitive)

The World Bank estimates that a 10% real overvaluation of currency can reduce exports by more than 4%, a concerning figure for a country already struggling with a narrow export base.

Weak Productivity Compounds the Problem

Nepal’s structural economic weaknesses are further amplifying the exchange rate challenge. Studies show that Nepal suffers from low labor productivity, particularly in key sectors such as manufacturing and agriculture.

Compared to countries with similar economic structures, Nepal’s industrial workers produce only about one-third of the output. This productivity gap makes it difficult for Nepali goods to compete internationally—even without currency distortions.

Experts argue that the combination of low productivity and an overvalued currency creates a “double disadvantage” for exporters.

Remittance Inflows Distorting Currency Dynamics

Another major factor influencing Nepal’s exchange rate is the strong inflow of remittances. High remittance earnings increase foreign currency reserves, which can artificially strengthen the domestic currency in real terms.

Data trends show an unusual divergence:

Around 2000: Nominal and real exchange rate indices both near 100
Recent years: Nominal index declined to ~80, but real index surged to ~130

This suggests that while the currency appears weaker externally, it is effectively stronger in purchasing power terms—further hurting export competitiveness.

The Policy Dilemma: Stability vs Competitiveness

The debate over revising the exchange rate regime is not new in Nepal. However, it remains highly contentious due to potential risks.

Arguments for review or adjustment:

Improve export competitiveness
Attract foreign direct investment (FDI)
Correct structural overvaluation

Arguments against change:

Risk of imported inflation (especially fuel and essentials)
Potential macroeconomic instability
Weak domestic production base unable to absorb shocks

Critics warn that premature devaluation could trigger inflationary pressures, particularly in a heavily import-dependent economy like Nepal, where fuel, machinery, and consumer goods dominate imports.

Political Spotlight: What Will RSP Government Do?

The issue has now entered the political mainstream. The Rastriya Swatantra Party, which is poised to form a majority government, had explicitly pledged in its election manifesto to review exchange rate policy and trade agreements.

The party has proposed forming a high-level expert committee—including internationally reputed economists—to conduct a comprehensive study before making any policy decision.

Economist and prominent RSP figure Swarnim Waglé, who is widely seen as a potential finance minister, has previously raised concerns about the limitations imposed by a fixed exchange rate on monetary policy independence.

His argument centers on a key macroeconomic constraint: under a fixed exchange rate regime, Nepal’s central bank has limited flexibility to independently adjust interest rates and manage liquidity, as it must prioritize exchange rate stability.

What Lies Ahead

With increasing international pressure, domestic economic challenges, and political commitment to reform, Nepal stands at a critical juncture in its exchange rate policy.

Any decision—whether to maintain, adjust, or abandon the peg—will have far-reaching implications for inflation, trade, investment, and overall macroeconomic stability.

As the new government prepares to take office, the question is no longer whether the debate will continue—but whether it will finally translate into policy action.