This is a quick observation of the appropriation of Nepalese Currency in the bordering Town. my observation is the elaboration of Rakesh Mishra’s query and PR Ligal’s genuine thought.
In principle if India had higher inflation than in Nepal, it may lead to a decrease in the value of Indian currency and thus, appreciation of Nepalese rupees. However, CPI-based inflation remains 7.38 per cent in y-o-y basis in Nepal but RBI projects 6.8 per cent for 2023 against upper target limit of 6%. Therefore, the difference in inflation could not be the case.
Secondly, the other reason is trade balance. If Nepal has exported more goods and services through the open border, it is possible to a limited scale the increase in demand of Nepali Rupees and alternatively NC’s appreciation. Considering the structure of import and export and border price fluctuations in some selected commodities, this could be a temporary phenomenon.
Thirdly, the differential interest rates between Nepal and India in selected products can also influence the exchange rate. Theoretically, higher interest rates between the two countries will attract foreign investment, leading to an appreciation of the currency. The track record and uncertainties in the current volume of trade, investment, inflation, and interest rate, it can safely be said to wait and see for any sort of policy changes that may have long-term impact.
Fourthly, when the demand for Nepali financial assets increases, their prices will rise, providing Indian investors with capital appreciation. This can encourage further investment, leading to an even greater demand for the Nepali rupee. Important issue to consider is while higher interest rates can attract investment and lead to an appreciation of NC, they may also have other side effects on the Nepali economy, such as increasing the cost of borrowing and reducing consumer spending. As a result, decision makers in Nepal must seriously consider the trade-off between attracting investment and maintaining economic stability.
The informal economy can create a parallel or unofficial market for currency exchange, where currency is traded outside of the formal exchange rate mechanism. If the NC appreciates against INR, it may cause the informal market to offer a more favorable exchange rate, attracting more people to participate in the informal market and increasing demand for NC. This situation can also encourage smuggling of goods from India to Nepal, as the price of these goods will be lower in Nepal relative to India. This can increase the demand for NC and contribute to its appreciation.
Lastly, the informal economy can lead to the rise of “gray economy”, where goods and services are traded outside of the formal economy. An appreciation of NC can make Nepali goods and services cheaper for Indian consumers, encouraging more trade in the informal sector and increasing demand for the Nepali rupee.
Although in a smaller scale, this unique scenario has emerged. The Nepali policy makers should immediately work out the benefit and cost of the growth of “gray economy” by seriously dragonizing the consequences of the level, trend and impact of the informal economy in overall economy and the consequences of the government’s mission to mainstreaming informal economy into the formal economy.