Study Report Suggests Shift from Rupee Peg to Floating Exchange Rate System

A study commissioned by Nepal Rastra Bank has recommended gradually replacing the long-standing fixed exchange rate system with the Indian rupee with a more market-friendly floating exchange rate regime.

The study, prepared with technical support from the Bank of Korea, noted that the current exchange rate arrangement no longer reflects the evolving economic realities between Nepal and India. Based on analyses of purchasing power parity and the real effective exchange rate, the report suggested the need to readjust the exchange rate, including a possible depreciation of the Nepali currency.

Nepal has maintained a fixed exchange rate with India since 1993, pegging Rs 160 to INR 100. Experts have periodically called for a review of this system. The Rastriya Swatantra Party, which is set to lead the new government, has also pledged in its election manifesto to study possible changes to the existing exchange rate regime.

The central bank’s study recommends transitioning, over the medium term, from the current Indian rupee-centric peg to a managed floating exchange rate system based on a multi-currency basket. The proposed basket would primarily include the Indian rupee, Chinese yuan and US dollar, with the euro and Japanese yen serving as secondary reference currencies.

Nepal Rastra Bank spokesperson Guru Paudel said that although the current exchange rate has remained unchanged since 1993, there is a history of periodic adjustments in the past.

“An exchange rate is not required to remain fixed indefinitely,” he said. “Even within a fixed exchange rate system, revisions can be made when necessary.”

Five-phase capital account liberalisation

The report also underscored the need for phased reforms, institutional preparedness and clear policy direction to successfully implement capital account liberalisation in Nepal.

Capital account liberalisation allows the free movement of capital across borders, including foreign investment inflows and outflows, cross-border asset transactions and unrestricted fund transfers. Nepal currently permits such movements only on a limited scale. Foreign investment remains restricted in certain sectors, and outward investment is currently capped at up to $1 million, mainly in the information technology sector.

The study stressed that achieving capital account convertibility would require an appropriate exchange rate and monetary policy framework, legal reforms, institutional readiness, and effective risk monitoring and mitigation measures.

It proposed a five-stage roadmap for opening the capital account: prioritising foreign direct investment and long-term strategic investments in the first phase; allowing non-resident Nepalis to invest in the stock market in the second; opening government securities to portfolio investment in the third; liberalising short-term external borrowing and cross-border banking investments in the fourth; and moving toward full liberalisation in the final phase.

The report also called for improving the quality and transparency of capital flows, maintaining strong fiscal discipline and ensuring low inflation to strengthen macroeconomic fundamentals.

As part of medium- and long-term strategies, it recommended gradual and conditional liberalisation, market-oriented legal reforms, adoption of interest rate-based monetary policy, and a flexible exchange rate system. It also emphasised the need to enhance coordination between capital market openness and domestic financial sector reforms, along with strengthening crisis response capacity.

Paudel stressed that a robust financial system, reliable foreign exchange sources and adequate safeguards against potential shocks are essential prerequisites for capital account liberalisation.