Now speculation is rife that the fall of the Nepali rupee will raise import prices and worsen the already intolerable inflation rate in the country. For many people, this incident was something that nobody asked for as it had nothing to do with our economy directly. It was merely a result of the system of fixed exchange rate between the two currencies.
But, like they say, every cloud has a silver lining. The devaluation of the Nepali rupee vis-à-vis the dollar has produced two favourable consequences. One, with the rise in the value of the greenback, the volume of imports bought with dollars is likely to be checked, and we can expect the problem of the trade deficit to become less intense. However, this effect could be very modest as Nepal’s trade with India accounts for more than half of the country’s total trade deficit, and the deficit problem in terms of Indian currency is more severe than the deficit in dollar terms. So, as long as the policy is not explicitly focused on the deficit with India, it is less likely that the overall trade imbalance will be reduced.
Two, it is true that a weakened rupee makes Nepali exports cheaper and possibly increase the international demand for them. Even though the import sector can be expected to respond to some degree, it remains doubtful whether the same can be expected from exports particularly for two reasons. While our export base is narrow and exporters are unconcerned about cashing in on the present opportunity, the international demand for them is inelastic or relatively unresponsive to price changes. Thus, even if export prices fall, there is no reason to be hopeful of a growth in exports.
Furthermore, the biggest concern about the freefall of the rupee is the risk of a constant rise in the price level. It has been anticipated that import prices will rise up to 20 to 30 percent if they are left neglected. Although the estimate seems to be arbitrary, it would be unfortunate to leave import prices unchecked as the pressure of inflation on the economy has already intensified and approached double-digit levels. Yet there is no indication of any move to manage this volatile situation. The monetary authority in the country has been immobile because it cannot do anything to the existing exchange system, and expects further upheaval if intervention is done to it. However, it is not reasonable to deliberately ignore the current currency turmoil considering it as an outcome of the fixed exchange regime we have with India. Therefore, the monetary authority has the responsibility to devise measures before the domestic price situation becomes more complicated.
The intervention, however, should neither disturb the existing exchange mechanism nor aggravate the current price situation. For that reason, it would be appropriate to have dual exchange rates, one with a cheaper and fixed rate of the dollar for the import of essential goods, and another with a flexible market rate for other purposes. We can afford to do this because our problem is neither related to a decline in the exchange reserve nor a real threat to foreign currency withdrawals. Very similar to the partial convertibility system of the Nepali rupee implemented in the early 1990s, this mechanism of differentiated exchange rates for the dollar can help maintain import prices of essential goods — such as petroleum products, fertilizers and selected raw materials and capital goods — which can have a multiplier effect on the economy. At the same time, the dual rate system allows sticking to the existing exchange regime without having to implement any direct intervention. However, it may require mechanisms to ensure proper allocation of lower-priced dollars, and this should remain in effect only temporarily until the foreign exchange market stabilizes.
Stability in the exchange market depends on developments in India since our exchange mechanism is tied to the Indian system. The government in India took steps to stabilize the currency market by releasing dollar reserves in July. As this piecemeal measure didn’t work, it has re-imposed capital controls on corporations and individuals to check the outflow of dollars, and raised the short-term interest rates recently to attract more foreign capital. So, although the current
situation resembles the Asian crisis of the late 1990s, one should not expect it to be as bad since India has control over the capital account to
protect it from panic withdrawals. This is what happened in East Asian countries which followed a liberal financial system.
src Kathmandupost
