In the strange geometry of global finance, fixed exchange rates are the equivalent of training wheels: helpful at first, but awkward the longer you use them. Nepal has long pegged its currency, the Nepali rupee, to its Indian counterpart at a fixed rate of 1.60 to 1. For a country so closely tied to its bigger neighbour—by trade, migration, remittances and history—the logic has seemed self-evident. But as Nepal’s economy grows more complex, and its policy ambitions more sophisticated, a question looms: should it let go?
Currency pegs have a noble lineage. From the gold standard of the 19th century to the dollar-based Bretton Woods system after the Second World War, anchoring exchange rates was long seen as the surest route to monetary credibility. In practice, it meant ceding monetary autonomy in exchange for stability and investor confidence. Nepal’s peg, introduced informally in the 1960s and fixed at the current rate since 1993, has served just that function. For decades, it helped anchor inflation, assure importers and avoid disruptive swings in cross-border pricing with India, its dominant trading partner.
Yet fixed regimes also come with rigidities. In theory, Nepal retains control over its monetary policy. The central bank, Nepal Rastra Bank (NRB), sets cash reserve ratios, conducts open market operations, among others. But in reality, its room to manoeuvre is limited. Any divergence from Indian inflation or interest rates risks undermining the peg. When India tightens monetary policy, Nepal must follow suit—or face capital flight and currency arbitrage. The fallout: policy made in Delhi, executed in Kathmandu.
The bind has grown more acute in recent years. In the wake of COVID-19 liquidity shortages became recurrent on top of a series of macroeconomic shocks. The current account deficit widened, due in part to a ballooning import bill and sluggish export growth— problems exacerbated by a currency that may be overvalued. Later, businesses complained of high interest rates and credit constraints.
Pegging to the Indian rupee implicitly ties Nepal to India’s trade dynamics, even when they diverge from its own needs.
Critics argue the peg distorts competitiveness. Nepalese goods are locked into a parity that may not reflect their real-world value. With north of 60% of Nepal’s exports destined for India, price alignment has been helpful. But it also deters diversification. For a country that imports almost everything—from fuel to fertiliser—being unable to adjust its exchange rate acts like a tax on domestic producers. A more flexible regime, say proponents, would allow the country to devalue during downturns, encourage import substitution and better absorb external shocks.
Supporters of the status quo retort the peg has held up surprisingly well. Inflation has largely remained within target since 2015, thanks in part to India’s own adoption of inflation targeting. Notwithstanding periodic overshoots in credit and money supply, inflation has not spiralled. For a developing country with shallow capital markets and limited monetary credibility, anchoring expectations to a larger, more stable neighbour may still be the lesser evil. The NRB, they note, has managed to achieve some policy autonomy by tweaking secondary tools even within the constraints of the peg.
Moreover, floating one’s currency is not without peril. Small economies that ditch pegs tend to find themselves at the mercy of fickle capital flows. Nepal’s central bank lacks the depth of reserves or credibility to defend a volatile currency. A float could invite speculative attacks, destabilise prices and deter investment—hardly ideal in an economy still recovering from the pandemic and persistently reliant on remittance inflows.
There are also political realities. The Indo-Nepal relationship is marked by more than mere trade: it is one of porous borders, intertwined labour markets and cultural closeness. The peg is as much an emblem of integration as it is a tool of economic policy. To abandon it would be to signal a move towards monetary nationalism—an act that may unsettle investors and strain diplomatic ties, particularly in times of regional tension.
Still, the strategic calculus is changing. Over time, Nepal’s economy is diversifying, however slowly. Its trade with China and other partners is growing, and ambitions for self-sufficiency in energy and agriculture are rising. A more autonomous monetary policy may one day be needed to support those aspirations. But the transition from a pegged to a floating regime must be managed with great care, lest the cure prove worse than the disease.
Monetary orthodoxy suggests caution, at least for now. A peg, though clumsy, still provides the nominal anchor Nepal needs. But the clock is ticking. As the nation’s economic geography broadens, its currency regime will need to evolve. The peg may not be abandoned overnight—but it would be wise to prepare for a future where Nepal no longer rides India’s monetary coattails.
After all, even training wheels must come off someday.
