On Friday, Nepali rupee dipped to a record low against the US dollar, plunging a full two percentage points. At the end of the trading day, a dollar was fetching Rs 89.80. Unfortunately, the outlook for Nepali currency is grim in the foreseeable future as the economic crisis in Europe continues to spook money markets around the world and people scramble for the safety of the US dollar. India’s currency, to which the Nepali rupee is pegged, has in the last one month been steadily losing its value against the greenback. India’s bloated current account and mounting fiscal deficits certainly doesn’t help. But the major blow to the Indian currency in recent times, as is true of other major Asian currencies, has been the roiling uncertainties in Europe. Economists are predicting a dire outlook for the whole Euro zone as Greece gets ever closer to defaulting on its payments. If Greece goes under, the prevailing belief is that it could take along other major European economies like Italy and Spain. In the worst case scenario of disintegration of the European single currency project, the world money markets are likely to enter an unprecedented era of volatility.
Nepal can do little given its peg against the Indian rupee. On Thursday, the Indian currency plunged to its historic low of IRs 55.47 against the dollar, sending the value Nepali currency crashing as well. There are both benefits and costs of such devaluation. On the downside, imports (expect from India paid for in Indian currency) carried out in dollars will cost more, thereby adding to the country’s already huge trade deficit—in the first three quarters of the current fiscal year the deficit went up to a worrying Rs 284.6 billion. Importantly, during the same period, trade deficit with India increased at 12 percent, while the deficit with other countries went up a whopping 31.9 percent. This trend indicates that Nepal stands to lose more than it can gain from currency devaluation. With a bigger export base, Nepal could certainly have gained. But years of instability and lack of even basic inputs like power and petro-products has instead contributed to close down of even existing industrial facilities.
Some economists believe Nepal should jettison its peg with the Indian currency and adopt a floating rate. The central bank has refrained as it believes a floating rate could bring undesired volatility in the Nepali money market. Indeed, it is hard to predict the impact of daily, unpredictable fluctuations in a huge money market of India on a tiny Nepal, which imports 60 percent of its products from the southern neighbor. Thus the peg is likely to stay. In this situation, the next best course of action would be to work towards revitalizing Nepali industries, particularly those related to areas of comparative advantage for Nepal like carpets, garments and herbal products. It was to meet this goal the 2010 Industrial Policy was introduced. The policy was aimed at promoting industrial activity, increasing employment and boosting exports, which will all be vital to improve the outlook of Nepali currency. Unless Nepal gets its own house in order, it will continue to be buffeted by the ill winds of the unpredictable global currency market.