Short lived – Rupee Depreciation

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    Course dollar increaseRecently, Nepali Rupees (NPR) hit an all-time low against the USD and other convertible currencies. This is the first time that the domestic currency has traded at 110 for one USD, which has become the fourth currency whose value has crossed Rs 100 mark, after pound sterling, Euro and Swiss Franc. NPR has been on a free fall for the last few months. The depreciation of domestic currency against major convertible currencies is not due to the weakening of Nepali economy, but rather due to the weakening of Indian Currency (INR) with which the NPR is pegged at 1 INR=1.60 NPR.

    According to NRB data, NPR has depreciated by around NPR 20 per USD in just eight months. Being an import-based economy, the depreciation of NPR against major convertible currencies, especially USD, makes a huge impact on Nepal’s economy. Goods imported from countries other than India have become expensive. Even from India, many raw materials are bought in USD, which has pushed up the production cost of industries. As a result, production costs are expected to have gone up by 20-22 percent.
    Nepal imports petroleum through the state-owned Indian Oil Corporation (IOC). The price rise in petroleum, retail goods and services will lead to an increased inflation rate. Hence, prices of domestically produced as well as imported products are expected to go up by 25-30 percent in the near future. The consumers will be the ultimate sufferers, especially during the festive season when major festivals like Dashain, Tihar and Chhath are around the corner. Similarly, Nepal Electricity Authority (NEA) has been severely affected due to NPR depreciation. It has had to pay more tariff to hydroelectricity projects for which the Power Purchase Agreement (PPA) was done in USD.

    The recent depreciation of NPR also affects banking business, as the number of Letter of Credit (LCs) opened per day has fallen by two-thirds. As the practice of hedging against exchange rate volatility is not common, importers hesitate to open LCs. They fear a further rise in the dollar price, and risk of possible losses. In the mean time, as the NPR continues to lose its strength against the USD, the Nepali bullion market faces significant negative impacts. Because of high volatility in gold price in the local market, the demand for gold—both for consumption as well as for investment—has fallen sharply, and gold stocks with banks are on the rise.

    As the USD becomes dearer, Nepal needs to allocate a huge sum for foreign loan repayment. The strengthening USD is pushing interest rates higher and exerting pressure on the central bank to manage a large foreign currency reserve for loan repayment. This will increase the country’s debts, which was 34.1 percent of the gross domestic product (GDP) in the fiscal year 2011/12. The currency devaluation is also likely to further widen trade deficit with India, Nepal’s largest trading partner. This is due to import payments made in USD, which is done by selling INR from NRB’s treasury. Since the INR has plunged to a historic low against the USD, NRB is forced to sell more INR for import payments.
    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 due to the strengthening of the USD. This will help maintain the country’s balance of payment (BOP) surplus. Likewise, income from tourism will also increase, as foreign visitors can spend more following dollar appreciation. 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 shortage, and labor disputes are seen as factors hindering the country’s export.

    NRB’s Perspective
    Although Nepal is exposed to high negative impacts on macroeconomic fronts, NRB—the authority that formulates and implements monetary as well as foreign exchange policies—has said this is the right time to promote industries that ensure increased value addition within the country. NRB staff, including the Governor, have argued that industries should wait to import raw materials until the dollar depreciates. But they urged exporters to boost their exports. The statement itself is contentious from policy perspective, and affects the investment environment and value/supply chain of the country.

    Although the falling NPR was making history every day, the central bank was not in a position to take measures to correct this situation. Rather, it stated that since the NPR had appreciated by 7-8 percent against the USD in the last two years in real terms, it is now in the self-correcting phase. According to NRB, there is no need to intervene in the country’s foreign currency market, as the FOREX reserve is strong enough and the current account surplus is healthy despite massive trade deficit.

    In the last fiscal year, Nepal’s current account surplus stood at Rs 57.6 billion, while foreign exchange reserve stands at Rs 533.3 billion. This is sufficient to import merchandise and services for approximately one year. NRB has stated that it is closely monitoring the development in the exchange rate and its consequences on the country’s macroeconomic situation.

    NRB has claimed that even if the current account heads to a deficit, its first step will be to reduce imports and increase exports. Reconsidering the foreign exchange regime with the INR and other currencies would be the last option, since the current depreciation of NPR is a short-term phenomenon. Therefore, taking a long-term policy departure on the country’s foreign exchange rate regime may not be appropriate.

    The author is deputy director of Confederation of Nepali Industries
    homnath.gaire@cnind.org

    Source : Republica