Under pressure
IN 1993, AS NEPAL bound its rupee to India’s, the logic was self-evident. Its largest trading partner and source of remittances conferred a rare anchor in a turbulent neighbourhood. A fixed peg of 1.60 to the neighbouring currency delivered price stability and predictable commerce. More than three decades on, that same anchor has become a drag.
Policymakers in Kathmandu now dream of an open capital account, one where money moves freely across borders, where Nepali tech firms can invest in Silicon Valley and foreign portfolio managers can buy local bonds without asking permission first. An ordinance last year allowed IT companies to invest up to $1m abroad, a small first step. The destination, however, remains blocked by the very mechanism that once guaranteed safety.
Nepal’s economy looks stable on the surface. Foreign-exchange reserves have swelled to an all-time high of $22.76bn, thanks to remittances from the Gulf, India and South Korea that account for more than a quarter of GDP. Growth is estimated at 4.9% for 2025, a decent clip after the balance-of-payments crisis of 2022. The Nepal Rastra Bank (NRB), the central bank, has earned credibility for its cautious hand.
Even so, a core tension runs underneath. A fixed exchange rate, free capital movement and independent monetary policy form the “impossible trinity”. No country can have all three at once. Nepal currently forgoes full capital mobility. It pegs to the rupee and maintains just enough monetary autonomy through controls. To liberalise the capital account means choosing: either break the peg or surrender control of interest rates to the Reserve Bank of India.
The peg itself has drifted from reality. Purchasing-power parity and real effective exchange rates suggest the Nepali rupee is overvalued against the Indian rupee by perhaps 5-15%, reckons the NRB. Inflation differentials and productivity gaps have accumulated since 1993, misaligning the currency. A devaluation would restore competitiveness.
Yet the bigger task is to loosen the tether altogether. The Bank of Korea, which runs knowledge-sharing programmes with emerging economies, has advised the NRB to consider a managed float anchored to a basket of currencies—the Indian rupee, the dollar and the yuan, say. Such a shift would grant Nepal room to breathe. It could set interest rates according to domestic conditions, not Delhi’s. It could absorb external shocks without depleting reserves in a futile defence of an outdated parity.
The path is littered with warnings. Thailand in 1997 had a fixed exchange rate and an open capital account, channelled through the Bangkok International Banking Facility. Short-term dollar debt piled up unhedged. When confidence evaporated, so did the baht.
Indonesia and South Korea suffered similar fates that same year, their strong fundamentals no match for currency mismatches on corporate balance sheets. Mexico’s “tequila crisis” of 1994 and Argentina’s collapse in 2001 offer their own lessons: pegs invite speculative attacks once capital can move freely.
Even successful liberalisation has required caution. China and Vietnam opened slowly, prioritising foreign direct investment over hot money, maintaining controls even as they grew. Malaysia, after its 1998 crisis, imposed capital controls and a peg, then relaxed them only when recovery was assured.
For Nepal the sequencing matters more than the speed. The Bank of Korea’s advisers recommend a staged approach. First, liberalise long-term equity and foreign direct investment: the sort of money that builds factories, not the kind that flees at the first sign of trouble. Next, allow non-resident Nepalis and foreign institutions to buy listed shares, with registration and disclosure requirements to ensure transparency. Then, permit investment in local-currency government bonds but only after the domestic bond market has sufficient depth and infrastructure to absorb flows without distortion. Finally, with buffers in place and hedging instruments available, consider opening short-term borrowing. The order is deliberate: stability-first, volatility-last.
Institutional reforms must accompany each step. The NRB needs a proper foreign-exchange information system to monitor cross-border flows in real time, something Korea developed after its own crisis. It should introduce a foreign-investor registration system, as many Asian economies have done, to know who is buying what and when. A real-name system for financial transactions would further illuminate the shadows.
And the toolkit for managing flows should expand: central-bank securities akin to Korea’s monetary-stabilisation bonds could mop up excess liquidity; macro-prudential measures could lean against credit booms; and judicious use of capital-flow management, as endorsed by the IMF’s integrated policy framework, could respond to surges and reversals without slamming the door entirely.
The biggest near-term risk comes not from Wall Street but from the wallet. Stablecoins, especially those pegged to the dollar, are creeping into remittance corridors. Nepalis working abroad increasingly send money home through digital channels that bypass the official system. If such flows grow large, they could undermine the rupee peg from below, creating a de-facto dual-currency regime. The central bank would lose visibility over the money supply and the exchange rate. A total ban, the instinctive response, would likely push the activity further underground. Better, as the Philippines has done with its regulatory sandbox for crypto-based remittances, to bring it into the open with clear anti-money-laundering rules and registration requirements.
All of this demands political will. Nepal’s High-Level Economic Reform Advisory Commission has signalled its intent. The ordinance allowing outward investment by IT firms shows that change is possible. But the central bank, long accustomed to the stability of the peg, must now embrace the uncertainty of flexibility. It must build deeper foreign-exchange markets, introduce brokers and derivatives, and extend trading hours.
It must also negotiate a new relationship with the Reserve Bank of India, one where the swap lines that provide emergency liquidity remain in place even as the exchange-rate link loosens. And it must convince a wary public that floating the currency is not an invitation to chaos but a necessary adaptation to a world where capital moves at the speed of a click.
The impossible trinity provides no escape. Nepal can keep its peg and its monetary autonomy only by keeping capital out. That approach has served reasonably well for over three decades. But the world has changed, and so has Nepal. The younger generation wants to invest abroad. Foreign investors want access to Nepali assets. Remittances, the lifeblood of the economy, are flowing through channels the central bank cannot see.
The choice is between managing the transition and having it forced upon you, rather than between reform and stasis. A devaluation today, a managed float tomorrow and a careful, sequenced opening over the next decade: that is the path the technocrats have mapped. Will politicians have the nerve to follow it? That is another question. ■
