By Sanjeev/Rashesh/Yagya

While almost every currency in the world is losing its price against the US Dollar, last week the Nepali Rupee was hit the hardest among all South Asian counterparts. The exchange rate between Nepali Rupee and US Dollar hit record high on Wednesday (June 12). The reference exchange rate set for that day by Nepal Rastra Bank was Rs 93.19 (for buying) and Rs 95.99 (for selling) per dollar. This is the highest after eight months. However, the banks can fix their own rate based on central bank’s reference rate.
The strengthening of USD has caused mixed reactions in South Asian Forex markets (see table and charts). Sri Lanka’s rupee fell on Thursday as foreign investors booked forwards to hedge their exposure, amid a trend of foreign outflows in other Asian peers in the wake of rise in U.S. Treasury yields. Maldivian Rufiyaa is seen relatively stable than other SAARC nation currencies as the country’s earnings from the tourism sector looked robust. Bhutanese Ngultrum which is pegged with Indian Rupee followed the path of Indian currency though the country’s economy seemed fairly strong in near and medium terms.

Meanwhile, Bangladeshi Taka maintained stable rate against the USD as earnings from the country’s garment exports increased further. Afghanistan’s currency Afghani is also seen as best performer as the country’s forex reserve increased due to the amount of financial aid from United States and it’s allies sharply rose. Pakistani currency didn’t witness substantial pressure in recent volatility as the new government unveiled a ‘business friendly’ budget and pledge to revive the ailing economy. The Chinese Yuan also performed better than some South Asian currencies though the government signaled to slow the pace of currency appreciation.

The weakness of the Indian currency is the main cause of the sharp devaluation of Nepali Rupee. On Thursday (June 20), the Indian Rupee hits a new all-time low against the USD trading at 60 per dollar. Nepali currency which maintains exchange rate peg with the Indian Rupee was hammered by the sharp decline. The Indian currency is under huge pressure as the country’s Current Account Deficit (CAD) continues to widen in a fast pace. Amid Weakening exports, spike in gold and petroleum imports are seen as the major factors for increasing India’s trade deficit which is ultimately widening the country’s CAD. The capital flight from India in recent months is also seen as another factor for weakening rupee as foreign investors are buying more greenbacks.



Fed’s policy reversal

The trend is blamed on the indication from US Federal Reserve that it would now reverse the policy of Quantitative easing (QE), thus signaling advent of tighter money supply policy. The improvement in US manufacturing, retail business and housing sector along with decreasing unemployment rate have prompted the Fed to make such policy reversal. Fed Chairman Ben Bernanke said on Wednesday the central bank will continue to reduce the pace of bond purchases in measured steps through the first half of next year, ending purchases around mid-year if the US economy continued to show strength. The Fed has been pumping massive amount of liquidity through the QE programme since 2008 to stimulate the US economy in the wake of global financial crisis. After Bernanke’s comment the long-term interest rates in US soared as investors flocked to more attractive government bonds. This resulted in sky rocketing the US Treasury yields to 10 year high causing a broad rally in USD.

In context to Nepali economy, the strengthening of the US dollar is seen as one of the factors of negative impact. For a country with the increasing trend of trade deficit, stronger dollar brings negative impact on the balance of payment of Nepal. Recent volatility indicates that weakening of Indian currency will continue in near-term. As a result, Nepali Rupee may further depreciate and weaken the economy which is already facing various macroeconomic risks. Analysts say that the possibility of capital flight from Nepal is very high by the continuous devaluation of Nepali Rupee. According to them, the combination of negative real interest rate and return on savings along with weak investment environment has created situation of large capital flight from the country.