Uttam Maharjan

The Nepali rupee is pegged against the Indian rupee. India is Nepal's neighbour and most of the country's trade is conducted with India. India is, therefore, our biggest trading partner. Moreover, the people of Nepal and India have special relations extending up to 'roti-beti' ones that have brought the people from both countries together to a people-to-people level. Nepal and India have adopted the fixed/pegged exchange regime, which is the system of pegging one currency against another, a basket of currencies or a commodity such as gold. Usually, a country with a weak currency intends to peg its currency against a more stable, stronger or internationally recognised currency to make it stable against market odds. The value of such a currency can stand up to market conditions.

Fixed currency rate
In 1944, when World War II was going on, a large number of countries made an agreement to peg their currencies to the US dollar in Bretton Woods, New Hampshire. They also agreed to fix the price of gold at 35 US dollars per ounce. The purpose of the agreement was to rebuild the countries ravaged by World War II through currency stabilisation programmes and infrastructure loans. This fixed exchange rate regime was in force from 1944 till 1971, when US President Richard Nixon nixed it by revoking the convertibility of the US dollar to gold. Thereafter, a mix of fixed and floating currency exchange regimes emerged.
The rupee was introduced into Nepal in 1932. At the time, there was a dual currency circulation system in the country. Both Nepali and Indian rupees were reckoned, as legal tender in the country. The Indian rupee, just like its Nepali counterpart, was freely in circulation. Private money changers would fix the exchange rate between Nepali and Indian rupees on the basis of demand for and supply of both currencies on a daily basis. Fluctuation of the exchange rate on a daily basis was not desirable as it would affect trade and other economic activities. So a means for stabilising the exchange rate was being explored when Nepal Rastra Bank, the central bank of Nepal, came into being in 1956. In 1957, the Nepali Currency Circulation and Expansion Act was enacted, and under the act, the dual currency system was abrogated.
In 1956 itself, Nepal Rastra Bank adopted a new stable currency regime, fixing the exchange rate of the Nepali rupee at 1.60 to the Indian rupee. The central bank could buy and sell Indian currency at this rate. To facilitate the exchange, exchange counters were set up across the country and banking institutions were instructed to facilitate exchange transactions. In 1966, the Indian government drastically devalued its currency. This monetary development helped the Nepali rupee to get revalued so much so that 101 Nepali rupees could buy 100 Indian rupees, making Nepali and Indian rupees almost equal.
From 1966 to 1993, Nepali and Indian rupees witnessed several changes in the exchange rate. In 1993, the Nepali rupee was again fixed at 1.60 to the Indian rupee. The Nepali rupee has since been pegged against the Indian rupee at the same rate. Now the question arises, whether this pegging system is beneficial to Nepal. Some argue that it is not beneficial. And attempts have also been made to remove the system. If Nepal Rastra Bank (NRB) wants to abolish the pegging system, it can do so because it has the right to do so. But before taking such an important step, many factors need to be taken into account.
The pegging system is beneficial for those countries that have weak economies that depend on foreign loans or that are import-based. Under the pegging system, trade and investments are facilitated and made more predictable. Being a weak country, Nepal has to depend on imports, foreign direct investment and foreign assistance/loans. The country's trade with India is bigger than with any other country. Moreover, the country's imports preponderate over its exports. The economic instability of the country has been kept down through the pegging system. De-pegging would encourage capital flight, affecting business, trade and other economic activities. It would also give rise to hyperinflation. In such a situation, the floating exchange system would not be suitable for the country.

Economic reform
The Nepali rupee is being devalued against other currencies. When the Nepali rupee was pegged against the Indian rupee at 1.60 in 1993, the value of the Nepali rupee was 45.59 to the US dollar. And the Indian rupee was valued at 28.49 to the US dollar. Now, the Nepali rupee has been devalued to 117 to the US dollar. If there had been no pegging system, the Nepali rupee would have been valued at 4.10 to the Indian rupee based on the 256 per cent increase of the US dollar against the Nepali rupee or the Indian rupee. As Nepal has to import goods in huge quantities from India, but for the pegging system in place the goods would have been far and away costlier, which would have hit the economy of the country harder.
So before thinking about de-pegging the Nepali currency from the Indian currency, it would be prudent to reform the economy first such as by jacking up manufacturing and production by developing the industrial sector, reducing imports through import substitution and increasing exports, thus making the country less dependent on imports and widening the export base. Under the existing circumstances, doing away with the pegging system would be a suicidal step that would play havoc with the national economy.

(Former banker, Maharjan has been regularly writing on contemporary issues for this daily since 2000. uttam.maharjan1964@gmail.com)