The Nepalese rupiah is linked to the Indian rupee. Nepal’s neighbour, India, accounts for the majority of the country’s trade. As a result, India is our largest trading partner. Furthermore, Nepalese and Indian people have special ties that go beyond ‘roti-beti’ and have brought people from both countries together on a personal basis. Nepal and India have implemented a fixed/pegged exchange regime, which involves pegging one currency to another, a basket of currencies, or a commodity such as gold. A country with a weak currency will usually strive to peg it to a more stable, stronger, or internationally recognised currency in order to keep it stable despite market fluctuations. Such a currency’s worth can withstand market fluctuations.
Fixed exchange rate
In 1944, during World War II, a large number of countries met in Bretton Woods, New Hampshire, to agree to peg their currencies to the US dollar. They also agreed to keep gold at a fixed price of $35 per ounce. The agreement’s goal was to use currency stabilisation programmes and infrastructure loans to help reconstruct countries that had been devastated by World War II. This fixed exchange rate regime lasted from 1944 until 1971, when US President Richard Nixon put an end to it by removing the US dollar’s convertibility to gold. Following that, a hybrid of fixed and floating currency exchange regimes arose.
In 1932, the Nepalese rupee was launched. The country had a dual currency circulation system at the time. Both Nepalese and Indian rupees were accepted as legal money in Nepal. The Indian rupee, like its Nepalese equivalent, circulated freely. On a daily basis, private money changers would set the exchange rate between Nepali and Indian rupees based on demand and supply for both currencies. Daily fluctuations in the currency rate were undesirable because they would disrupt trade and other economic operations. When Nepal Rastra Bank, the country’s central bank, was established in 1956, it was looking for a way to stabilise the currency rate. The Nepali Currency Circulation and Expansion Act was passed in 1957, and it abolished the dual currency system.
The Nepal Rastra Bank established a new stable currency regime in 1956, establishing the Nepali rupee’s exchange rate at 1.60 to the Indian rupee. At this rate, the central bank might purchase and sell Indian currency. Exchange counters were erected up across the country to ease the exchange, and banking institutions were directed to facilitate exchange operations. The Indian government depreciated its currency dramatically in 1966. This monetary growth aided the revaluation of the Nepali rupee to the point that 101 Nepali rupees could buy 100 Indian rupees, making the two currencies nearly equivalent.
The exchange rate between the Nepali and Indian rupees changed numerous times between 1966 and 1993. The Nepali rupee was set at 1.60 to the Indian rupee again in 1993. Since then, the Nepali rupee has been tied to the Indian rupee at the same rate. The question now is whether Nepal will benefit from this pegging scheme. Some claim that it isn’t advantageous. There have also been attempts to deactivate the system. The Nepal Rastra Bank (NRB) has the authority to eliminate the pegging system since it has the legal authority to do so. However, several aspects must be considered before taking such a significant step.
The pegging method is advantageous for countries with weak economies that rely on foreign loans or are import-dependent. Trade and investment are facilitated and made more predictable under the pegging system. Nepal, as a poor country, must rely on imports, foreign direct investment, and foreign assistance/loans to survive. India is the country with which the country trades the most. Furthermore, the country’s imports outnumber its exports. The pegging mechanism has kept the country’s economic turmoil to a minimum. De-pegging would encourage capital flight, which would have a negative impact on business, commerce, and other economic activity. Hyperinflation would result as well. The floating exchange system would not be appropriate for the country in this case.
Reforming the economy
In comparison to other currencies, the Nepalese rupee is depreciating. In 1993, when the Nepali rupee was pegged to the Indian rupee at 1.60, the value of the Nepali rupee to the US dollar was 45.59. In addition, the Indian rupee was worth 28.49 US dollars. The Nepalese rupee has now been devalued to 117 US dollars. Based on the 256 percent growth in the US dollar versus the Nepali rupee or the Indian rupee if there had been no pegging system, the Nepali rupee would have been valued at 4.10 to the Indian rupee. Because Nepal imports commodities in large numbers from India, the goods would have been significantly more expensive if the pegging system had not been in place, putting a strain on the country’s economy.
So, before considering de-pegging the Nepali currency from the Indian currency, it would be prudent to first reform the economy, such as increasing manufacturing and production by developing the industrial sector, reducing imports through import substitution, and increasing exports, reducing reliance on imports and broadening the export base. Getting rid of the pegging system under the current conditions would be a catastrophic move that would wreck the national economy.