I co-authored my latest piece with Adnan. It is about the issues encircling balance of obligations deficit and the pegged exchange rate between the Nepali rupees (NRs) and Indian rupee (IRs). Taking a look at the options open to the Nepali central bank or investment company, neither revaluation is good nor devaluation is good. Given the dire state of the Nepali overall economy, sticking with the prevailing peg is the best option.
Here can be an additional blog post on the problem. The rumors about a possible change in trade rate picked up much steam because the economy experienced around Rs 20 billion opening in the balance of payments (BOP) in the first half of the fiscal year. To douse potential speculative strike on the money, the fund secretary and the fund minister had to place out statements stating that the exchange rate won’t change as of now. Even the central bank or investment company has been pressured to create a formal statement.
Given the condition of our economy right now, remaining the course, i.e. sticking with the existing exchange rate peg, appears to be the best option. Probably the most pressing macroeconomic problem right now is to find ways to slim current accounts deficit and close the gap in the BOP. The surge in imports and decrease in remittances and exports have activated this unlucky situation. A revaluation of the currency is out of the question since it would not address the core problems.
In fact, it would widen current account deficit as imports from India become relatively cheaper to local consumers. Meanwhile, imports of Nepali items by Indian consumers would become expensive. It seems sensible to revalue Nepali rupee against the Indian rupee if the demand of Nepali export items by Indian consumers is inelastic, i.e. no matter by how much prices change, Indian consumers would demand Nepali items. This is clearly not the case. In fact, the Indian market already has close substitutes of almost all the things Nepal exports.
Devaluation seems to be the most popular option among experts of the Nepali overall economy. At present, it is certainly a better case than revaluation but a weaker case than the position quo. You can find short-term benefits and long-term risks associated with devaluation. Devaluation – a deliberate downward adjustment in the state exchange rate – will reduce the currency’s value. By making exports less costly, and discouraging imports, devaluation can indeed lessen current account deficit. If things come out this way, then devaluation is not bad for the Nepali economy. However, the monetary and trade engines set in motion once it does not stop there; devaluation is not devoid of dire economic consequences.
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First, by increasing the price of imports and stimulating demand for exports, devaluation increases financial activity but aggravates inflation potentially. But, the high inflation rate will force the government to raise rates of interest to control spiraling price rises, which is already hovering around 12 percent in Nepal. As a consequence, the higher interest rates will cause a slower rate of financial growth by discouraging consumption and reducing investment by firms.
Moreover, the inflation genie is out of the bottle once, we will have to let go a lot of financial growth before inflation can be contained again. The story of inflation is a bit more complicated than what some are arguing simply that devaluation will lead to a short-term high-inflation, but a long-run low-inflation.
Economists and policymakers could have a simpler life, if it was this straight-forward. It makes sense to revalue Nepali rupee against the Indian rupee if the demand of Nepali export items by Indian consumers is inelastic, i.e. no matter by how much prices change, Indian consumers would demand Nepali items.