--By Sanjeev Sharma

 

The sharp devaluation of the Nepali rupee (NPR) is causing various macroeconomic impacts on the Nepali economy. The local currency which maintains an exchange rate peg with the Indian rupee (INR) has depreciated by about 13 per cent between 1st May and 9th August of 2013 against the US dollar. The weakness of INR is caused by India’s slowing economic growth combined with a widening current account deficit (mainly due to rising petroleum and gold imports), decline in exports and the strengthening of the US dollar as economic recovery in the US gathers pace.    

 

With the NPR continuously losing strength against the USD, the Nepali economy is facing significant negative impacts. As the USD becomes dearer, Nepal needs to allocate a huge sum of funds for foreign loan repayment. The strengthening USD is pushing interest rates higher and exerting pressure on the central bank to manage a huge foreign currency reserve for loan repayment. This will increase the country’s debt which was 34.1 per cent of the gross domestic product (GDP) in the fiscal year 2011/12. Nepal’s debt to GDP ratio is following a declining trend from the record high of 44 per cent in FY 2007/08.

 

The currency devaluation is also likely to further widen trade deficit with India, the largest trading partner of Nepal. This is due to import payments that are made in USD, which is done by selling INR from Nepal’s forex reserve. Since the INR has plunged to a historic low against the USD, Nepal is forced to sell more INR for import payments. In the 11 months of FY 2012/13, Nepal’s trade deficit with India jumped by 27.4 per cent to Rs 289 billion compared to the 13 per cent growth recorded in FY 2011/12. Since Nepali production is insufficient to fulfill internal demand, the country relies heavily on import. This will be reflected in the increase of the final price of retails goods and services in the domestic market. Petroleum import will also become costlier due to the currency devaluation. The international petroleum price, which is maintained in dollar terms, has gone up in recent months due to the rise of USD.

 

Nepal imports petroleum through the state-owned Indian Oil Corporation (IOC). The price rise in petroleum, retail goods and services will finally lead to an increased inflation rate. 

 

Though the impacts are largely negative, currency devaluation has some positive effects like Remittance, Nepal’s major source of foreign currency income is likely to rise by the strengthening of the USD. This will help to maintain the country’s balance of payment (BOP) surplus. According to data published by Nepal Rastra Bank (NRB), the overall BOP recorded a surplus of Rs. 52.69 billion during the 11 months of FY 2012/13 compared to a surplus of Rs. 115.76 billion during the same period of the previous year. Likewise, income from tourism will also increase as foreign visitors can spend more following the dollar appreciation. Similarly, Nepali export earnings, especially from merchandise goods such as handicrafts, garments and carpets may increase as exports will become more competitive with the weakening of domestic currency. However, Nepal may not be able to take advantage of currency depreciation from export earnings due to several reasons. High cost of production due to rising price of imported raw materials, long-standing electricity shortages and labour disputes are seen as factors hindering the country’s export sector.