To Peg or Not to Peg

Nepal’s economic story has been premised on a script heavily shaped by our neighbourhood. Geography, trade patterns and political history are structural features of the Nepali economy. Perhaps nowhere is this reality more obvious than in the quiet but consequential matter of the Nepal-India currency exchange rate peg. 

This peg has been around since the 1960s. It has been revised multiple times, usually in response to balance of payments stress or exchange rate misalignments. Over the years, the peg has settled at NPR 1.6 per INR 1, becoming something of an anchor not just for traders and bankers, but also for households who instinctively benchmark value in relation to India.  

As Nepal grapples with pressure from rising import costs, a stubborn current account deficit and a difficult geopolitical environment, the question why haven’t we revisited the peg in a more fundamental way keeps getting debated. Does keeping it actually serve Nepal’s long-term strategic interest, especially when the Nepali rupee floats against other convertible currencies? 

The obvious answer is straightforward: the peg has survived because it has been the least risky option for an import-heavy under-developed economy with weak buffers. Yet, the deeper answer is more nuanced and central to Nepal’s broader economic evolution. 

The Peg’s Enduring Logic 

Roughly two-thirds of Nepal’s trade either goes directly to India or passes through India primarily due to logistical reasons. Most of our essential goods, from fuel to food to pharmaceuticals, move through Indian ports, railways and roads. Our largest source of imported goods is India. Our biggest source of informal cross-border trade is, again, India. 

In a perfect world, Nepal would have a diversified export base, large reserves, deep financial markets and a truly independent central bank with decades of proven credibility. But Nepal’s reality is a massive trade imbalance with a single partner and extremely narrow foreign exchange market. A peg provides discipline and predictability. It anchors inflation expectations and reduces exchange rate risk in the majority of cross-border transactions.  

This is not unusual for small economies. Hong Kong pegs to the US dollar. Several middle eastern economies peg to the dollar. Smaller African economies peg to the euro. Pegs survive because they work; until they don’t. And the burden of proof always rests on those arguing for a change. 

Floating but Anchored 

One may argue that Nepal already allows the Nepali rupee to float against other major currencies, so why not unshackle ourselves fully? The argument sounds logical on the face of it but it misses the core mechanics. 

Nepal’s ‘floating’ rates against USD, EUR, GBP and others are not necessarily the product of supply and demand in the domestic forex market. They are derived rates: banks look at the INRUSD rate, apply Nepal’s fixed NPR-INR peg to calibrate the rates for NPR against other currencies. There is no real floating market behind these calculations. 

This means Nepal effectively runs an anchored exchange rate system. The rupee’s relationship with the Indian currency determines almost everything else. That has been the default and a design choice.  

Political Debate 

Foreign exchange discussion often veers into a territory that sounds political, as if currency regimes are symbols of national sovereignty. Many Nepalis ask whether the peg reinforces geopolitical dependence. It’s a fair question. Currency pegs inevitably tie your monetary policy to the policy of the anchor country. If the anchor country raises rates, you feel it. If the anchor experiences inflation, you import some of it. If the anchor faces a financial shock, your currency trembles. In our case: when India sneezes, Nepal gets flu. 

But the uncomfortable truth is that geopolitical dependence isn’t created by a currency peg, and breaking a peg will not magically produce strategic independence. A country’s economic autonomy is built on diversified trade, fiscal discipline, robust domestic production, strong and credible institutions, etc. More than anything else, currency regimes are tools. And tools should be judged by how well they work, not by what they are perceived to represent. 

Windows and Perils 

There was a context in the 1990s when de-pegging perhaps looked plausible. Those who didn’t live through the early 1990s cannot fully appreciate how different Nepal felt then. The 1990 Jana Andolan had cracked open political space. The economy was liberalising rapidly, faster in some respects than India. Import licence raj was dismantled, tariffs were being slashed, the financial sector was modernising + expanding, foreign investment rules were easing and a new generation of private enterprises was emerging. At the same time, on the other hand, India was wrestling with its own balance of payments crisis. The Indian rupee was under stress, foreign reserves precariously low and the country had to pawn gold to keep the ship afloat. 
It was one of those rare windows where it looked like Nepal might leapfrog economically ahead of its neighbours. Against that backdrop, Nepal’s peg began to feel less like stability and more like a lost opportunity. 

My own thinking back then tilted toward de-pegging or at least radically re-engineering the peg. If Nepal was reforming faster, opening sooner and diversifying more boldly than India, why chain our monetary fate to an anchor that was itself struggling? In fact, the central bank and the ministry of finance were understood to have engaged in reviewing the peg in some form. But these conversations lost momentum as history chose a different script. Nepal’s early reform momentum fizzled. Political instability crept in. Institutions weakened. And as the decade progressed, the first signs of the insurgency began to simmer. The window for a bold monetary experimentation closed almost as soon as it appeared. 

Fast-forward to 2006. The Maoist insurgency ended and Nepal entered a hopeful but fragile peace. People were exhausted: emotionally, financially socially. They had sacrificed too much and gained too little. We needed a confidence boost. Something symbolic yet practical. Something that could lower prices, make households breathe easier and signal that peace wasn’t just political theatre but a turning point for ordinary Nepalis. 

A favourable re-pegging, i.e., strengthening the NPR relative to the INR, could have delivered precisely that. Cheaper imports. Lower inflation. A sense that the country was resetting, rebalancing and rewarding its citizens for a decade of suffering. A peace dividend. While economists will tell you that exchange rate adjustments don’t magically create real income, post conflict economics rarely follow theories and textbooks, sentiments and expectations matter.  

However, the macro-economic fundamentals were too weak. Reserves were shaky. Institutional credibility was questionable. More importantly, the end of insurgency was followed by a prolonged period of wrangling over a new constitution, which eventually got done only after the massive earthquake injected a sense of urgency.  

Today, our nation is neither the reformist dream of the early 1990s nor the hopeful Nepal of the post-conflict era. Today, we face a more mundane challenge: an economy stuck in structural rot, a demoralised private sector, weak productivity and institutions that deliver little. Our state machinery is transactional at the top, confused at the bottom laced with corruption and weak governance all around. 

Today, I view the peg with a more sober, pragmatic lens. Because, unhooking the rupee from the Indian currency in the current context would result in economic turbulence. With shallow markets and limited reserves, the NPR would experience sharp movements. Even if the fundamentals ultimately favoured stability, the early days would be turbulent. And inflationary pressure could be insurmountable. Most of Nepal’s imports are essentials with inelastic demand. Even a small depreciation of 10-20% would raise domestic prices overnight. And since cartels and intermediaries already exploit any excuse to raise prices, the inflation shock would likely be larger than what pure economics predicts.  

The Real Work Lies Elsewhere 

I am now older and wiser to understand that if Nepal wants real monetary autonomy someday, the path does not begin with the exchange rate. It begins with hard structural reforms: the sort politicians and bureaucrats have failed to deliver because they lack glamour and take years to show results. To address Nepal’s desire to gain monetary autonomy, we must implement the following strategies to (a) Strengthen the export base. 

Nepal’s export sector, encompassing hydropower, tourism, food processing, niche manufacturing and computing capacity powered by clean energy, holds significant potential as a path to generate more foreign currency, thereby reducing its dependence on remittances. (b) Build sustainable reserves. A robust reserve buffer serves as a safeguard against economic shocks in a floating currency regime. Nepal has experienced periods of low reserve levels, which have posed risks to its financial stability. (c) Modernise foreign exchange markets. Nepal’s foreign exchange markets require modernisation to enhance their functionality and efficiency. This involves developing robust forwards, swaps and hedging tools. Additionally, it is essential to establish direct pipelines to global platforms, enabling Nepal to access global market opportunities and enhance its competitiveness. 

In trying to escape the gravitational pull of geopolitics, Nepal must not forget that relative economic stability is one of its hardest-won assets. The peg, as such, is not the chain holding Nepal back. The chain is its structural weakness. And while a peg may appear old-fashioned, there is nothing wrong with old-fashioned tools as long as they do their job.  

Managed Crawl 

But it is certainly not necessary to cling to the peg forever simply because it’s familiar. Nepal should absolutely revisit the peg when we need to but only out of confidence based on economic fundamentals.   

When we do embark on that journey of serious structural reforms, we can think of a sensible middle path which could be a rule-based adjustable peg or crawl: a system that keeps the rupee tied to the INR but allows small, transparent adjustments over time. It keeps us anchored but gives us room to breathe. It lets us correct misalignments gradually, rather than through sudden shocks. And it allows the central bank to manage the currency regime more proactively.  

Why am I Sharing This Evolution of Perspective? 

Because Nepal’s currency debate is not just about economics. It’s a story of changing national moods, changing contexts and changing possibilities. In the early 90s, Nepal felt ahead of the region, so de-pegging made sense. After the conflict, Nepal needed a peace dividend, so re-pegging made sense. Today, Nepal needs stability and discipline, so maintaining the peg makes sense. For now, the peg endures because Nepal itself is still figuring out what kind of economy it wants to be. Nepal will earn monetary autonomy the day it earns true economic resilience. Not a day sooner. 

And we will get there. But only if we do the hard, unglamorous work first.