India’s decision to demonetize high denomination Indian currency notes has created a historic opportunity for Nepal to do away with the practice of pegging Nepali currency with that of India. The reluctance of the Indian authorities to accept the now demonetized Indian notes is in fact compelling Nepal to unpeg.
It is an opportunity because the benefits for Nepal from unpegging far outweigh the losses. If Nepali authorities put the arguments logically, chances are high that the Indian authorities may ask not do go ahead with unpegging and in exchange they may readily accept all the Indian demonetized notes that are in Nepal, within or outside the Nepali banking system. Indian currency till November 8, 1016 was a legal tender in Nepal not only in practical sense (general acceptability) but also in legal sense as all the banks were readily accepting Indian currency from anybody without asking any question. Yes, questions are asked in case of substantially big amount, but that is normal also in case of big amount in Nepali currency. The only exception is that Indian currency is not allowed to be used as unit of account for government purpose.
It was not a unilateral decision of Nepal government to give this status to Indian currency. There are number of agreements and exchanges of paper between Indian and Nepali authorities to facilitate this. By not accepting Indian notes from Nepal suddenly from November 8, 2016, India has violated those agreements.
If Nepal removes the peg, India will lose a large captive market that it has been enjoying in Nepal. There are many Indian businesses that are almost entirely dependent on Nepal market. So are the border area marketplaces such as Jogbani, Sitamadhi. Raxaul, Nautanwa, Rupaidiha etc.
If the Nepali currency is unpegged from Indian currency, Nepali customers of these businesses will have to pay in convertible foreign currency. If they have to do that, they can make the same purchase from third countries as well, say from Bangladesh or Thailand. That will force the Indian businesses to offer more competitive benefits to the Nepali buyers.
With the ongoing peg, the Nepali buyers of these Indian goods feel that they are trading in local currency. But in fact they are not. The Nepalis are getting Indian currency notes from Nepal Rastra Bank which purchases those notes from Reserve Bank of India by paying convertible foreign exchange such as US Dollar, Euro, Yen etc. Thus Nepal is effectively paying India in convertible foreign exchange though people don’t realize this as this is camouflaged by Nepal Rastra Bank.
Proposal to unpeg Nepali Rupee from Indian Rupee has been cropping up time and again, but every time that is put aside with a counterargument that some Nepali people will suffer if there is no such peg. The examples given are of those who live near the border with India, those who have family relations in India, students who are studying in India, people who have to go to India for medical treatment and for pilgrimage. But the banking system is so much advanced now that all these groups will adapt to the changed situation soon with some educational efforts from Nepali authorities and banks.
Most importantly, the unpeg will make it possible for Nepal to follow a really independent monetary policy. Right now it is following what Reserve Bank of India does, most important example being the fixation of foreign exchange rate. In this system, we don’t know what the real value of our currency is. So, unpegging is needed also for truly autonomous Nepali economy.