Is peg to Indian currency still relevant?

******* ANALYSIS******

-----------------Rupee freefall against US dollar--------------------

PRABHAKAR GHIMIRE

KATHMANDU, Aug 20: The Nepali rupee has been pegged to the Indian rupee at Nepali Rs 160 to Indian Rs 100 since March 1, 1992, when one US dollar exchanged for Rs 49.

Over the last two decades, the exchange value of the greenback has more than doubled, but the exchange rate of the Nepali rupee with the Indian rupee is still the same.

At a time when the Nepali rupee has been hitting one new low after another in recent days on the back of pessimism over the Indian economy, the relevance of continuing to peg the Nepali currency to the Indian rupee has been questioned.

The currency peg benefitted Nepal in the past as the southern neighbor saw high economic growth and robust foreign currency reserves.
“But the time has come to rethink the peg system. With the Indian currency losing strength sharply against the US dollar, we have to prepare gradually to end the pegging by consolidating our own economy,” said economist Keshav Acharya, former chief of Research Department at Nepal Rastra Bank.

However, Nepali officials dare not question the continued relevance of the peg to Indian currency at a time when Nepal´s economy is marred by double digit inflation, slowing growth, a ballooning trade deficit and declining industrial growth, among other woes.

The currency peg has made Nepal highly dependent on Indian imports as other foreign currencies have surged over the period, causing the cost of overseas imports to surge way past imports from India.

“With the country fully embracing an open market economy, it will not be wise to prolong the currency peg indefinitely. The peg meant suffering the adverse impact of a weakening Indian economy,” added Acharya, also a former chief economic advisor at the Ministry of Finance.

The Indian rupee hit another low of 64.04 against the dollar on Tuesday, in early trading at the inter-bank currency market here. Responding to the value of the Indian currency, the Nepali rupees plunged to Rs 102.05 per dollar, breaking Monday´s record of Rs 100.6.

Acharya claimed that the Nepali currency would not have dropped that much had Nepal adopted an open market valuation system. Instead of the peg, Nepal can level the value of its currency through reviews at certain intervals. However, Acharya thinks terminating the existing system of currency valuation would be hard to execute.
“We can´t end the pegging system overnight but we can review the exchange rate of both currencies at certain intervals,” Acharya said.

Nepal has to undergo massive market management to contain the spiraling inflation -- upsetting the informal economy which hovers around 40 percent of total economic activity, establish a sound banking system, and maintain good governance. In view of all this, the government, which had mulled ending the peg to the Indian currency a few years back, eventually balked at the idea.

Dr Bishwombher Pyakuryal, another economist, has flatly denied the viability of ending the currency peg, given Nepal´s weak economic performance. In the face of skyrocketing imports and slowing exports, Nepal has seen its current account surplus drop to around Rs 57 billion from Rs 76 billion last year. Similarly, the balance of payments tumbled to Rs 69 billion from around Rs 132 billion over the year.

“It is not easy to end the peg as floating the exchange rate of the Nepali rupees in the open market will destabilize the Nepali economy which is already in various difficulties,” he said.

Meanwhile, the Nepali rupee weakening against the dollar means more reasons to be upset than than to be upbeat.
The government can mobilize more customs duty, VAT and excise duty with the rise of the import bill jacked up by the rising value of the dollar. But the stronger dollar has driven up the import price of raw materials for manufacture, spawned double digit inflation, and worsened the trade deficit.

With the whopping rise in civil servant salaries and industrial worker wages as well as hike in petroleum prices pushing up inflation, a rising import bill will further worsen the situation.

“If this continues, inflation will increased by at least 6 percentage points as against the government´s target of containing it at 7.5 percent this year,” added Acharya.
Apart from overseas goods, Nepal been importing some seven dozen items from India with payment in US dollars.
Pyakuryal also estimated that inflation will hit double digit this year.