Inflation in Nepal looks higher than in India. This is due to the fact that in Nepal we use consumer price index for calculating inflation and India they use wholesale price index. It is a well known fact that consumer price index always and everywhere will be higher than the wholesale price index. This particular fact has been well explained in The Economist magazine in its June 9, 2007 issue. So, once we take into consideration the open border between our two countries and the system of fixed exchange rates as well as the unlimited convertibility of Indian Rupee in Nepal, apparently, there is no reason why the inflation rate should be significantly different between India and Nepal.
Yes interest rate is much lower in Nepal. This basically reflects the boom being experienced in the Indian economy and the sluggishness in the Nepali economy. When there is such a large difference between the growth rates of the two countries, such differences in the interest rates is not unnatural. One additional factor responsible for this phenomenon is the fact that in India demand for credit is growing by some 30 per cent while the deposit is growing by some 16 per cent.
Conceptually, there is no direct relationship between the Money Supply growth and the need for either appreciation or depreciation of the exchange rate.
Yes, the forex reserve in Nepal is growing at slower pace than in India. This is a fact and the factors responsible for this are too apparent. The main factor responsible for this is the high capital inflows being recorded in India. On the one hand foreigners are pouring money into India and domestic entities in India are borrowing huge money from external sources.
Nepal has never enjoyed trade surplus either with India or with the rest of the world. But the important question here is not the volume of deficit, but the sustainability of such deficit. Looking into the Balance of Payment surplus situation and the country's foreign exchange reserves we need not worry about the deficit volume.
So, the overall comment is:
Yes Nepali Rupee is appreciating in terms of convertible currencies. Normally when we have that type of appreciation, it is followed by pressure in the Balance of Payment. This is reflected in the fall in the foreign exchange reserves of the country. But this has not happened in Nepal. Foreign exchange reserves of the country is increasing. There has been no decline in the foreign exchange which commercial banks has been selling to the central bank. Remittance flows into the country has not declined. The decline is not in the volume but in the growth rate. The high growth rates which were recorded in the past, can not be expected to continue for ever and this is what is happening right now.
So looking into all these factors, there is no need to have a policy turn around.
Lessons from history:
It has been observed from empirical evidence that countries that try to keep their currencies overvalued are in fact subsiding the imports and undercutting the exports. Currencies that are artificially kept high ultimately lead to the collapse of the economy as a whole. Recent macro economic history of the world offers ample evidence to this effect. A typical example in this is the Latin American nation Chile where a fixed nominal exchange rate was combined with high domestic inflation.
As part of its plan to bring down the Chilean inflation, the government had fixed the exchange rate in the middle of 1979 at 39 pesos to the US Dollar. Over the next two and a half years, the Chilean price level rose 60%, while US prices rose by only about 30%. Thus by early 1982, the Chilean peso had appreciated in real terms by approximately 23% against the US Dollar.
An 18% corrective devaluation was enacted in June 1982. But it was too late. The artificially high peso had already done its double damage to the Chilean economy: It made Chile's manufactured products more expensive abroad, pricing many of them out of international trade; and it made imports cheaper, undercutting Chilean domestic industries. The effects of the overvalued peso was that many companies were thrown into bankruptcy; copper mines were closed, construction projects were shut down and farms were put on auction block. Unemployment approached 25% and some areas of Chile resembled industrial graveyards.
Conclusion:
From the foregoing discussion it is crystal clear that NPR now stands over-valued and needs an immediate correction. Wait and watch approach might result in economic catastrophe. Positive BoP alone can't sustain the overvalued NPR. Authorities will have to take timely decision. Time and tide wait for no one. If we lag on taking proper decision now, time itself will decide the future course of action, which definitely will come as a shock to all of us and we will pay the price for this unwarranted risk.
BY
K B Manandhar
Deputy Governor, Nepal Rastra Bank
Yes interest rate is much lower in Nepal. This basically reflects the boom being experienced in the Indian economy and the sluggishness in the Nepali economy. When there is such a large difference between the growth rates of the two countries, such differences in the interest rates is not unnatural. One additional factor responsible for this phenomenon is the fact that in India demand for credit is growing by some 30 per cent while the deposit is growing by some 16 per cent.
Conceptually, there is no direct relationship between the Money Supply growth and the need for either appreciation or depreciation of the exchange rate.
Yes, the forex reserve in Nepal is growing at slower pace than in India. This is a fact and the factors responsible for this are too apparent. The main factor responsible for this is the high capital inflows being recorded in India. On the one hand foreigners are pouring money into India and domestic entities in India are borrowing huge money from external sources.
Nepal has never enjoyed trade surplus either with India or with the rest of the world. But the important question here is not the volume of deficit, but the sustainability of such deficit. Looking into the Balance of Payment surplus situation and the country's foreign exchange reserves we need not worry about the deficit volume.
So, the overall comment is:
Yes Nepali Rupee is appreciating in terms of convertible currencies. Normally when we have that type of appreciation, it is followed by pressure in the Balance of Payment. This is reflected in the fall in the foreign exchange reserves of the country. But this has not happened in Nepal. Foreign exchange reserves of the country is increasing. There has been no decline in the foreign exchange which commercial banks has been selling to the central bank. Remittance flows into the country has not declined. The decline is not in the volume but in the growth rate. The high growth rates which were recorded in the past, can not be expected to continue for ever and this is what is happening right now.
So looking into all these factors, there is no need to have a policy turn around.
Lessons from history:
It has been observed from empirical evidence that countries that try to keep their currencies overvalued are in fact subsiding the imports and undercutting the exports. Currencies that are artificially kept high ultimately lead to the collapse of the economy as a whole. Recent macro economic history of the world offers ample evidence to this effect. A typical example in this is the Latin American nation Chile where a fixed nominal exchange rate was combined with high domestic inflation.
As part of its plan to bring down the Chilean inflation, the government had fixed the exchange rate in the middle of 1979 at 39 pesos to the US Dollar. Over the next two and a half years, the Chilean price level rose 60%, while US prices rose by only about 30%. Thus by early 1982, the Chilean peso had appreciated in real terms by approximately 23% against the US Dollar.
An 18% corrective devaluation was enacted in June 1982. But it was too late. The artificially high peso had already done its double damage to the Chilean economy: It made Chile's manufactured products more expensive abroad, pricing many of them out of international trade; and it made imports cheaper, undercutting Chilean domestic industries. The effects of the overvalued peso was that many companies were thrown into bankruptcy; copper mines were closed, construction projects were shut down and farms were put on auction block. Unemployment approached 25% and some areas of Chile resembled industrial graveyards.
Conclusion:
From the foregoing discussion it is crystal clear that NPR now stands over-valued and needs an immediate correction. Wait and watch approach might result in economic catastrophe. Positive BoP alone can't sustain the overvalued NPR. Authorities will have to take timely decision. Time and tide wait for no one. If we lag on taking proper decision now, time itself will decide the future course of action, which definitely will come as a shock to all of us and we will pay the price for this unwarranted risk.
BY
K B Manandhar
Deputy Governor, Nepal Rastra Bank
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