Pegging or Letting Go

The debate over Nepal’s long-standing currency peg with the Indian rupee (INR) has returned to the policy agenda following the resounding victory of the Rastriya Swatantra Party (RSP) in the March 5 elections and subsequent government formation under its leadership.

The party had proposed commissioning an academic study to reassess the fixed rate of Rs 160 to INR 100. With the party enjoying a strong mandate, the issue is now at the center of national discussion.

Economists say the timing may be favorable, pointing to a strong Balance of Payments position, rising foreign exchange reserves, and a stable government capable of taking long-term decisions.

The debate, however, is not new. In the past, the issue was sidelined by political instability. It often resurfaces when the US dollar strengthens. This is because the peg to the Indian rupee makes imports costlier and fuels inflation.

Nepal imports far more than its exports. This means the country absorbs the costs of currency depreciation without gaining much in competitiveness. The local unit’s weakening against the greenback reflects its link to India more than Nepal’s own trade position. Many economists say this calls for a deeper review of the peg.

In recent years, the issue was first raised by the Rameshore Khanal-led High-level Economic Reform Advisory Commission. It later appeared in the RSP’s election manifesto. Now, a new study by the Nepal Rastra Bank (NRB) has added weight to the debate. While the central bank’s report, Liberalization of Foreign Exchange Policy and Capital Flow Management, does not call for an immediate change, it raises a key question: can a policy unchanged for more than three decades still hold? Nepal has long maintained a fixed exchange rate of Rs 1.60 per Indian rupee, anchoring its currency to that of its largest trading partner. This arrangement has placed Nepal within the so-called rupee zone which helps stabilize prices, reduce exchange rate volatility, and ease trade and remittance flows.

In those days, the logic was clear. Nepal’s economy was small and heavily dependent on India. It also lacked the institutional capacity to run an independent monetary policy. That logic, the central bank suggests, is weakening.

Stability at a Cost

While the currency peg has long been seen as a pillar of macroeconomic stability, it comes with trade-offs. As India’s economy has expanded and diversified, the gap between the two economies has widened significantly. Differences in productivity, industrial capacity, and technology are now more pronounced. Under a fixed exchange rate regime, this has led to what economists call a structural overvaluation of the Nepali rupee. In simpler terms, imports become cheaper and exports less competitive. The effects of currency beg are visible across sectors. Nepal’s import dependence has deepened, domestic manufacturing has struggled to gain traction, and export performance has remained subdued. At the same time, the central bank has limited room to use monetary policy tools like interest rates and liquidity management to respond to domestic economic conditions.

The issue is not just about trade competitiveness, but also about policy autonomy. Economists describe this constraint through the “impossible trinity.” A country cannot have all three: a fixed exchange rate, free capital movement, and full control over monetary policy. By maintaining the peg, Nepal has effectively traded away some monetary independence.

Signs of Misalignment

There is also growing evidence that the current exchange rate may no longer reflect economic fundamentals. Estimates based on international benchmarks suggest that Nepal’s real effective exchange rate (REER) may be overvalued. World Bank indicators point to an overvaluation of around 8%, while IMF-based estimates place the range between 8% and 18%. An overvalued currency makes exports more expensive while making imports cheaper. Over time, this weakens domestic production, and discourages investment in tradable sectors. It also reinforces reliance on remittances and consumption.

Remittances add another layer to the complexity. With large inflows of foreign currency, the real exchange rate tends to appreciate, a phenomenon often associated with “Dutch disease.” Combined with inflation in non-tradable sectors such as real estate and services, this has further eroded competitiveness. Against this backdrop, the NRB report, carried out under the Bank of Korea Knowledge Partnership Program, stops short of calling for a sudden break from the peg. Instead, it calls for a gradual and carefully managed recalibration. In the short to medium term, the report suggests that a modest adjustment in the peg level could help realign the currency with economic fundamentals. Based on theoretical models and international experience, it identifies a depreciation range of 5-15% as a reasonable starting point under non-crisis conditions. Applied to Nepal’s current peg, this would imply a shift from Rs 1.60 per Indian rupee to a range of roughly Rs 1.70-1.85.

The report, however, states that stable macroeconomic conditions, including manageable inflation, adequate foreign exchange reserves, and a stable financial system, should support any adjustment in the currency peg to avoid shocks.

A Cautious Move

The new government has the political space to act. The RSP has already committed to reassessing the fixed exchange rate regime. Economists, however, say the issue should be handled cautiously.

Former NRB Executive Director Gunakar Bhatta says any decision must be based on careful analysis of the real effective exchange rate, external sector conditions, and broader macroeconomic indicators. “Calls for exchange rate adjustments are not new. Nepal revised its rate eight times before 1993,” Bhatta said. “But any change in the exchange rate regime, such as moving toward a free or managed float, would require deeper study. It is important to understand both the risks and the opportunities.” The risks of a poorly managed adjustment are significant. Given Nepal’s deep trade ties with India, a sharp depreciation could trigger inflation and disproportionately affect lower-income households. With weak domestic production, higher import costs would quickly pass on to consumers.

Another former NRB Executive Director Nara Bahadur Thapa also advises a gradual approach. He, however, adds that the current political stability offers an opportunity for a serious review. “Any move away from the peg must be gradual and phased, with a clear understanding of risks and opportunities,” he said. “Even though the peg may reflect economic weaknesses, it should not be maintained indefinitely without question. That said, Nepal must strengthen its economic fundamentals before considering any major shift.” NRB Spokesperson Guru Paudel says the exchange rate has been revised multiple times in the past. “Therefore, it is not impossible to adjust the exchange rate again,” he said. “A fixed exchange rate does not necessarily have to remain fixed forever.” Paudel adds that Nepal must strengthen its financial system and ensure stable sources of foreign exchange before opening the current account. “Nepal should be capable of withstanding major shocks or crises, and there must be reliable and sustainable sources of foreign exchange,” he added.

One of the less explored aspects of the debate is the peg’s link to investment. The current peg, while offering stability, may also act as a constraint for investors outside India. A more flexible and market-based exchange rate could make Nepal more attractive for investors, especially as it looks to diversify economic partnerships. At the same time, greater flexibility also brings risks. Exchange rate volatility can create uncertainty, especially in the early stages of transition. Without adequate safeguards, the economy could face capital outflows reversals and financial instability. This is why the central bank’s emphasis is on gradual change.

Beyond the Peg

The debate is not just about adjusting the peg. It is about rethinking the system itself. The NRB has suggested a long-term shift toward a more flexible regime, possibly a managed float. As a step in that direction, it has proposed exploring a multi-currency basket system. Instead of anchoring the Nepali rupee solely to the Indian rupee, the currency could be linked to a basket of major currencies such as the Indian rupee, US dollar, Chinese yuan, and euro.

Given Nepal’s deep integration with India, the Indian currency will continue to dominate in the exchange rate regime. However, the inclusion of other currencies would better reflect Nepal’s evolving trade and economic relationships.

The report outlines a step-by-step approach. It starts with redefining policy objectives, including establishing a clear inflation anchor and ensuring external stability. This is followed by strengthening legal and institutional frameworks, building foreign exchange reserves, and developing financial market infrastructure.

As exchange rate flexibility increases, businesses and financial institutions will need access to instruments such as forward contracts and swap arrangements to manage currency risk. Flexibility could be introduced through a narrow band around a central rate, which can be widened over time as markets adjust. Clear communication will be important to maintaining confidence and avoiding speculative pressures.

A Turning Point

For decades, the peg has provided stability. It has supported trade, anchored expectations, and safeguarded the economy from volatility. But the economy is changing and the limits of that stability are becoming more apparent.

The central bank has not prescribed an immediate shift. But it has opened the door to a deeper question: how closely should Nepal tie its currency to India’s, and at what cost?

The answer will not come overnight. But the debate has clearly moved forward. It is no longer about whether to review the peg, but how to manage change without losing stability.

This report was originally published in April 2026 issue of New Business Age magazine.