The Nepali rupee suffered the largest single-day drop of 1.01 against the United States dollar to sink to an all-time low of 130.90 on Tuesday.

According to reports, the rupee’s plunge is an effect of the steady depreciation of the Indian rupee to which it is pegged.

The strengthening of the greenback will further widen the trade deficit for an import-based economy, experts say. The appreciation of the dollar may fuel inflationary pressure.

On the positive side, a stronger greenback means higher remittance earnings in terms of Nepali rupees, experts say. Since Nepal has been performing poorly on the export front, a stronger dollar will not benefit the country much.

“Being an import-based economy, the appreciation of the dollar means higher cost of imports, fuelling inflation further,” said Gunakar Bhatta, spokesperson for Nepal Rastra Bank, the country’s central bank.

“The appreciation of the dollar is also an opportunity for export, tourism and remittances. But if we look at the country’s export trade, its base is small, amounting to just Rs200 billion annually,” he said.

"Tourist arrivals have slowed and remittance is also on a steady growth trend, so the rising dollar has nominal gains for Nepal. As the festival season has begun, the stronger dollar will increase the purchasing power of Nepalis who send remittances home," said Bhatta.

"But at the same time, import costs will increase, which will deplete the country's foreign exchange reserves faster."

Consumer spending accounts for 90 percent of Nepal’s Rs4.8 trillion GDP, according to Nepal Rastra Bank. This translates into a monthly consumption of Rs400 billion which swells in September and October during the festival season.

According to Bhatta, the dollar soared after the Federal Reserve Bank, the central bank of the US, increased the interest rate for the fourth time this year—by 0.75 percent three times and 0.50 percent once.

On September 21, the Federal Reserve Bank increased the federal fund rate from 2.5 to 3.25 percent. The federal fund rate is the inter-bank interest rate which was increased by 0.75 percent.

“The increase in the interest rate by the central bank of the US impacts the economies of emerging and developing countries,” Bhatta said.

"With the Fed increasing the interest rate, global investors turn to the US which increases demand for dollars, pushing up its cost against other currencies in the international market," he said.

"This situation led to a depreciation of the Indian currency, and it dragged down the Nepali rupee with it. But even if the Nepali rupee was not pegged to the Indian rupee, it would still sink as export earnings are minimal, and it would have been difficult for Nepal to manage its currency,” he said.

Nepali currency becomes strong automatically when Indian currency is strong, and weakens when Indian currency weakens.

Nepal has been following a pegged exchange rate system with the Indian rupee with periodic exchange rate corrections through revaluation or devaluation.

Nepal adopted a different kind of exchange rate system for convertible currencies.

In line with the economic liberalisation policy followed since the mid-1980s, Nepal introduced current account convertibility in 1993, effectively pegging the Nepali rupee to the Indian rupee at the rate of 1.60, the same exchange rate which was fixed in 1960 when the two currencies were pegged for the first time, the report said.

Since 1993, the exchange rate of the Nepali rupee with other convertible currencies has been market-determined in line with the exchange rate of the Indian rupee with convertible currencies.

“If there would have been a normal situation, the increased interest rate would not have pushed the dollar up. But as the uncertain economic situation in many countries created due to the war between Russia and Ukraine, the rise in the interest rate by the Federal Reserve Bank made the US a safe haven for investment,” Bhatta said.

"In this situation, the only move the government can make to control the foreign exchange reserve is to control imports," said officials.

"Observing the depreciating currency with a strong dollar, chances of the government’s extending the import restrictions have increased. Looking at the foreign exchange level, the restrictive measures on the import of non-essential goods need to be extended.”

An embargo on 10 types of products deemed “luxury goods” has been in place since April 26 to conserve foreign currency. On July 17, the Nepal government extended the embargo till August 30.

When the ban was first imposed in April, the government prohibited imports of mobile sets worth over $600 and motorcycles with a capacity of over 250 cc.

When that failed to stem the outflow of foreign currency, harsher restrictions followed and mobile sets costing more than $300 and motorcycles with a capacity of more than 150 cc were banned.

Nepal's total imports declined by 13.01 percent to Rs273.59 billion in the first two months of the current fiscal year ended mid-September, compared to the same period of the last fiscal year 2021-22, according to the Department of Customs.

The government has continued restrictions on the import of automobiles, mobile phones, liquor and motorcycles until October 14.

Keshav Acharya, an economist, said that the depreciation of the Nepali currency has more negative aspects, except for remittances.

“We have been importing cereals worth Rs400 billion annually, and the appreciation of the dollar will increase food prices sharply,” Acharya said, adding that the impact on the overall economy would be severe as the value of the country's imports are equivalent to more than 35 percent of its GDP.

The government debt servicing rate will also increase, and as the Nepal Electricity Authority has done most of its power purchase agreements with the power producing companies in dollars, the stronger dollar means costs will increase.

According to Nepal Rastra Bank, the year-on-year consumer price inflation stood at 8.26 percent in the first month of the fiscal year, compared to 4.35 percent a year ago.