IMAGE: BARON REZNIK
FOR FOUR DECADES the arrangement worked without much thought, which is usually the sign of a good arrangement. Nepal pegged its rupee to India’s at a fixed rate—160 Nepali rupees to 100 Indian—and in doing so imported a degree of monetary credibility that its own political turbulence could never have supplied. Inflation tracked India’s. The central bank could spend its energy on other things. The system was so reliable that it became invisible, like the plumbing behind a kitchen wall.
That plumbing is now gurgling loudly. India’s rupee has been sliding against the dollar, dragged down by surging oil prices, sustained capital outflows and the gravitational pull of a strong American currency. On March 23rd it traded at a record low of 93.98 to the dollar, having lost more than 7% since the start of the year. Because Nepal’s rupee is pegged to India’s, it has slid in lockstep, touching 149.3 to the dollar—a record low. The plumbing was meant to transmit stability; instead it is transmitting pressure.
The proximate cause is oil prices. When conflict in the Middle East pushed crude above $100 a barrel earlier this month, India, which imports 85% of its oil, faced a sudden need for dollars. Its trade deficit widened. The Reserve Bank of India (RBI) has been selling dollars from its reserves to slow the rupee’s fall but its firepower is finite. Foreign investors have pulled $9bn from Indian equities in 2026 so far, adding to $19bn in outflows last year. They are selling rupees and buying dollars, putting further downward pressure on the currency. The RBI can lean against the wind but it cannot reverse the gale.
For Nepal, which has no control over its own exchange rate, the consequences are immediate. The country is ferociously import-dependent. In the first seven months of this fiscal year, it imported goods worth Rs1.12trn and exported just Rs168bn. Those numbers, ugly in any context, become more dangerous when the currency weakens. Each percentage-point fall in the rupee raises the domestic cost of everything Nepal buys from abroad: from fuel, cooking gas and medicines to construction materials.
Price pressures from abroad are now feeding into the economy. Fuel prices have leapt. And food becomes more expensive across the board. Because Nepal’s economy lacks the productive base to substitute for imports, the price increases feed into consumer inflation without any compensating boost to domestic output. Salaries, which are set in rupees, do not rise as fast. Purchasing power erodes. For a country where nearly 20% of the population still lives below the poverty line, the effect is the difference between feeding a family and not.
The weakness also accelerates the depletion of foreign-exchange reserves. The Nepal Rastra Bank, the central bank, must supply dollars to finance imports, and those dollars are now more expensive in rupee terms. The country’s reserves have been a bright spot, recently reaching $22.5bn, enough to cover nearly two years of imports. That cushion owes more to remittances—workers abroad sent home nearly $12bn last year—than to any export prowess. But a cushion is not a bulwark. If the rupee continues to slide, the central bank will face a choice: let reserves shrink or tighten monetary policy in ways that choke domestic demand.
That choice is made harder by a second vulnerability that has crept up largely unnoticed. Nepal’s government has abandoned its long-standing practice of borrowing cheaply from multilateral lenders and switched to domestic debt. In 2020 domestic debt stood at Rs613bn. Five years later it has more than doubled to Rs1.27trn. The shift matters because the terms are so different: World Bank loans cost under 2% and run for 40 years; domestic treasury bills mature in 91 days and must be rolled over constantly. When interest rates spiked during a balance-of-payments wobble in 2021-22, the rate on 91-day paper shot from 2.2% to 9.5% in a year. The government was rolling over large chunks of its domestic stock at those peak rates. The bill is now arriving.
Debt service has risen 171% in five years, making it the fastest-growing item in the government accounts. For every Rs100 the treasury collected in revenue last year, nearly Rs27 went to servicing past borrowing. The IMF has suggested that a debt-service-to-revenue ratio above 18% warrants attention. Nepal is at 26.8% and climbing. At that rate, within a few years debt service will swallow 30% of revenue. When that happens, discretionary spending collapses. Capital expenditure—already chronically poor with roads and dams perpetually delayed—gets crushed first.
What makes the situation more than the sum of its parts is the interaction between the currency peg and the fiscal bind. A weakening rupee raises the cost of servicing the foreign portion of the debt, which is denominated in dollars. At the same time it pressures the central bank’s reserves, which are also denominated in dollars, even as the government’s domestic borrowing costs remain sensitive to any tightening in liquidity. The peg, which was meant to be a source of stability, has become a transmission mechanism for stresses that Nepal cannot control and cannot easily mitigate.
The big institutions expect more weakness. Nomura and Goldman Sachs have projected the Indian rupee reaching 95 or 96 to the dollar in the near term. If that happens, Nepal’s rupee would weaken further, past 150. The country would then face the full force of the feedback loop that haunts small, open economies with fixed exchange rates: a weaker currency raises import costs, which widens the trade deficit, which puts further pressure on reserves, which raises the risk premium on domestic debt, which crowds out investment, which reduces the export base. Nepal’s export sector, stripped of the temporary illusion of edible-oil re-exports, is barely larger than it was a decade ago.
None of this has yet produced a crisis. Remittances remain robust. The banking system is liquid. Concessional financing from multilaterals is still available. The conditions under which structural problems are easiest to address are exactly the conditions that now prevail: when there is time to think rather than to panic. Whether the new government, which has promised to double the size of the economy in seven years, will use that time to wean the country off import dependency and domestic borrowing is another matter. ■
