Allow us, as non-monetary economists, to point out certain fundamentals in the making of Nepal’s Monetary Policy. At the outset, we would like to put the focus on Nepal’s currency union with India and its pros and cons. A currency union is fine if Nepal happens to be a trading nation, especially a large exporter, because it provides exchange stability. Has anyone calculated the loss of revenue from under-invoicing and the loss of currency from its retention overseas? We submit it is humongous.

Pegging the Nepali rupee

Clearly, the currency union means loss of exports and opportunities for import substitution, especially in agriculture and manufacturing. It is tantamount to subsidising Indian exports by the amount of the over-valuation of the Nepali rupee. It supports balance of trade and current account deficit that leads to a structural balance of payments deficit. The drawing down of Nepal’s dollar holdings to pay for Indian rupees will cause interest rates to rise as Nepal Rastra Bank buys Nepali rupees and thus reduces the money supply.

The currency union, further, will be a strong factor to importing inflation plus, and that ‘plus’ can be seen to be equal to the inefficient transport cost of 2 percent or more. Freedom of transport and transit would benefit Nepal with greater service revenue in Indian rupees. But the transport cartels do not wish to be in competition and force Indian transporters to unload at the customs point causing additional transhipment costs. If policymakers wish to accomplish the export freedom of transit and transportation for Nepal, the bill of lading may be helpful in facilitating it.

Pegging the Nepali rupee to the India rupee also means dollar appreciation in line with India’s move. What happens to this currency union if India, like China, moves towards full capital convertibility? We submit it will collapse. Additionally, we submit the point that because the interest rate of Nepal is pegged, its monetary policy does not respond to local realities regarding boosting household saving and private sector investment.

Progressive policy

What kind of monetary policy would we like for Nepal? We envision the route of resources which can maximise household saving and maintain an attractive savings rate that must stand higher than the inflation rate. Next, the maximisation of national capital formation should be the top priority. To this end, it is necessary to introduce lower interest rates for investors with minimum spread rates for different kinds of investment loans. Also, a policy should be made to discourage corporates from buying treasury bills and government bonds which are income tax exempt.

By fixing trade bottlenecks and ushering the tax regime towards a goods and service tax (GST), Nepal will be better positioned to cope with the fiscal challenges emerging through a federal system. To improve the case of domestic production, generate income and decent savings and finally free the country from the clutches of poverty, unemployment and outbound migration, the adoption of a human face of economic reforms is a prerequisite, and those at the helm should not overlook it.

History will be kinder to those who will be votaries of low income, road and vehicle taxes, currently the components that discourage a culture of entrepreneurship, inclusive growth and prosperity and help encourage a shadow economy through unethical trade practices and black marketing. With a benign dividend and capital gains tax structure, Nepal’s economy will emerge as an attractive investment destination. By introducing capital accounts convertibility and integrating even more closely with the Indian economy, namely through capital and labour mobility, a new chapter can be written on the economic front, and that will be in the best national and regional interest.

However, this dream can’t be realised if Nepal further maintains a currency union with free labour movement where remittance outflow to India is estimated to be around $3 billion per year—nearly 50 percent of Nepal’s overseas remittance earnings and equal to the amount of dollars sold for Indian rupees to keep the currency pegged.

Finally, we refer our readers to a brilliant study done by Prof John Shambaugh of Dartmouth College on the pros and cons of a currency union, and appeal to the finance minister and central bank governor to fund an independent empirical research in our national context using the stellar ideas as a guiding force. The time is ripe to think and do out of the box, for an aspirational country like Nepal, keeping policy progressive and mass-oriented is critically important. The political economy should support the wave of mass aspirations.  

Rana is a former Nepali finance minister and an economist, and Thakur is a New Delhi-based columnist