An overvalued currency

Many of us may find appreciation of our currency, vise-a-vi US dollar, both in nominal and real terms, perplexing at a time when our economy has stagnated and exports have sharply decelerated. Indeed, appreciation of Nepali currency witnessed in the last couple of months appears little odd when analyzed against major economic fundamentals, which are not at all encouraging. It may be mentioned, to be specific, that the economy is likely to grow by less than 2.5 percent as against an earlier prediction of five percent and Nepal's trade deficit with its major trading partners is on the rise.
When compared to a year earlier level, deceleration in exports and capital expenditure is distinct. Economic activities are slacking yet inflation level, around six percent, is much above the expected rate of economic growth. In a nutshell, the available data do not justify any appreciation of our currency against any worth mentioning currency of the world, let alone US dollar against which it has registered a nominal appreciation of 13 to 14 percent in the last 7/8 months.

All this confusion is cleared once we understand that our currency has to walk the line drawn by Indian currency, it being pegged to IC at1.60NC= 1.0 IC, and that this appreciation is the result of a genuine appreciation of currency of India that has performed superb economically registering a growth of nine percent.

Export growth has maintained its momentum in spite of the appreciation in currency and industrial production index has registered an encouraging growth in recent times, reaching 11.1 percent in the 11 months of 2006/7 from 8.1 percent achieved in the corresponding period of the previous year.

The major concern of the Indian authority currently is to increase the access to resources of people living in rural India where poverty is still rampant and to achieve around 9 percent growth in a sustainable manner without getting into an intolerable level of inflation. The monetary authority there wishes to contain inflation at or below 5 percent level.

With Indian economy doing so good on all fronts, the major concern rightfully is stabilization. It can be concluded that the appreciation of Indian currency is on the strength of its economy that has witnessed, among others, impressive productivity enhancement in the manufacturing sector.

In nominal terms, NC cannot appreciate against IC in the fixed exchange rate regime but some marginal appreciation of our currency in real terms could be possible on account of price differentials in the two countries.

With US dollar, however, NC has appreciated in real terms also, because in addition to the nominal appreciation of 13/14 percent, level of inflation, included to calculate real effective exchange rate (REE), is much higher in Nepal as against an inflation level of 2/3 percent in developed countries.

Even strong economies do not welcome an appreciation of their currencies, one vivid example being China, which is allowing its currency to appreciate gradually and only marginally notwithstanding tremendous pressure from its trading partners in the west to allow Yuan appreciate significantly. So sensitive are Chinese to matters affecting their economy that the recent increase in the level of inflation from an expected 3 percent to 3.5, said to be a result of significant increase in pork meet prices, has attracted the attention of no less a person than the prime minister of China who has assured people that efforts will be launched to increase the supply of pork to contain price increase.

In our case, however, nothing can be done at the present juncture to correct artificial appreciation of our currency, which is doing more harm than good to our economy. Dwindling exports and decline in export receipts can be blamed on unrest and power shortage and a host of other impediments but at the same time negative effect on these of an overvalued currency cannot be undermined.

After the nominal appreciation of NC by about 14 percent against dollar, workers' remittances coming into the country through the organized sector are beginning to decrease, increasing at a decreasing rate, exporters are taking their time to declare their earnings and are hesitant to accept orders from importers overseas as they have Rs 75, previous rate, and current rate of Rs 65 to a dollar in their mind.

When depreciation of NC is not possible, some other measures such as export subsidy and tax relief measures could be taken resort to along with productivity measures to mitigate the adverse affect on our exports of such an artificial appreciation in currency. In other words, the diminished ability of our products, resulting from currency appreciation, to compete with products from other countries in terms of price has to be regained. At the same time, industrialists should take advantage of weak dollar in reducing the cost of production of various products which can be effective through import of raw material both from India and other countries: our central bank allows import of certain items from India paying dollar instead of Indian currency.

So should Nepal Oil Corporation (NOC) try to take advantage of the weakening dollar may be by rearranging its marketing methods/procedures. NOC should also attempt to synchronize its retail price with crude oil prices on the global market because a consumer finds inexplicable the static oil prices here in the face of volatile oil prices that have ranged between dollar 54 to 70 a barrel in recent times on the world market.

In the current fluid situation, any policy decision that tends to hike prices of essential items should be avoided because we have seen the consequences of oil price increases in last august when the violent street agitation forced the concerned authorities to roll back price hike. Therefore, instead of helplessly watching the artificial appreciation of our currency, the concerned should try different ways such as productivity enhancement, subsidy, tax relief, dependable power supply etc but no currency devaluation in the short run.

(The Kathmandu Post, June 16, 2007)