Foreign exchange of Nepal: A Brief History

Different currencies and the need to exchange them had existed since the Babylonians (who are credited with the first use of paper notes and receipts). Foreign exchange or foreign currency is the currency of an overseas country, which is purchased by a particular country in exchange for its own currency. The foreign exchange rate is the price of a country's currency in terms of another country's currency. The exchange rate is crucial in maintaining balance of receipts and payments between two trading countries. Understanding of the history of a countries exchange rate is important to formulate the country's exchange rate policy.

Commercial relationship between Nepal and India has existed more than five hundred years before Christian era. By first half of seventh century when the Lichhavis were ruling, Nepal had become the country of transit trade between India and Tibet. Barter system prevailed during those days. Nepal was divided into various small states, few states had there own metallic currencies. Exchange rates during that era were determined according to the market. Metals like gold and silver was mostly used as means of exchange. It was only after unification of Nepal did have a single currency. But minted coins came into use only after Jung Bahadur Rana set up a minting machine in Kathmandu.

Nepal has a rich history on foreign exchange. Evolution of Nepal's exchange rate policy begun only after unification of Nepal in 1769. We moved from having no defined exchange rate policy, but being market determined, to have clear exchange rate policy. Nepal's foreign exchange policies can be differentiated into six distinct periods. These periods are:

Floating exchange rate period
Prior to establishment of Nepal Rastra Bank, many currencies along with Nepalese currency were circulated in Nepal. The value between each currency was determined by market. Fluctuations in supply and demand of currencies were reflected in the floating rates. However, the currency was metallic and its value was based on metallic content. It existed up to 1956.

Dual currency period
Our country had dual currency from 1835 to 1934. Both Nepalese currency and Indian currency were used as currency of exchange in Nepal. Indian paper currency was acceptable for heavy transactions. Both Nepalese and Indian paper and metal currencies circulated. It lasted up to mid 20th century. In Kathmandu, Nepalese currency dominated whereas in Terai (near the border of India) Indian currency was heavily circulated but in hilly regions barter system still prevailed.

Pegged exchange rate period
1951 to 1955 was extremely volatile in respect to Nepalese currency-Indian currency exchange market. Changes occurred daily. Fluctuation in the value of Indian currency against value of Nepalese currency remained a source of unnecessary irritation and trouble for all walks of life until 1957 when the system of dual currency system was abolished under Nepal Currency Circulation and Expansion Act. Due to the volatile market of Nepalese currency and Indian currency and its adverse effect on confidence of Nepalese currency and economy of Nepal, the dual currency system was abolished and a single currency was fixed. Nepalese currency was pegged with Indian currency with unlimited convertibility at the fixed rate of 160NC to 100IC. Nepalese currency has been fixed with Indian currency for last 40 years with only 7 changes in the exchange rate so far.

Dual exchange rate period
After World War II, the foreign exchange market of the world became volatile. In order to bring economic order, United Nations Monetary Fund convened the Bretton Woods Accord. It established the policy of pegging currencies against the U.S. dollar so as to bring stability to a fractured and volatile global economic situation.

The first element of the Accord was to peg the U.S. dollar to the price of gold at $35.00 an ounce (The gold standard). With this benchmark anchoring the U.S. dollar, other major currencies were pegged to the greenback and allowed to fluctuate no more than 1% on either side of the pegged rate.

With accordance with the Bretton Woods system, Nepal Rastra Bank pegged 1 USD with 7.60 Nepalese currency. As Nepalese currency was already pegged with Indian currency, we adopted a Dual pegged system, i.e., one with USD (7.60=1USD) and second with Indian currency. This period extended from 1960 to 1973.

Basket of currency period
After collapse of Bretton Woods System in 1971, Nepal adopted the basket of currency system from 1983 to 1992. On June 1st 1983, Nepalese currency was pegged with basket of currencies. Basket of currency includes number of currencies based on trade weights. The exact composition of basket of currencies had not been divulged by Nepal Rastra Bank. Indian currency was also included in basket of currency, so Nepalese currency-Indian currency rates also changed on daily basis during that period.

Floated exchange rate periodBasket of currency system was discarded in 1992 and Nepalese currency was floated according to the demand for and supply of the market. Nepalese currency-Indian currency was again pegged at 160 Nepalese currency for 100 Indian currency. Other currencies were floated under supervision of Nepal Rastra Bank, i.e., from 1992 onwards Nepal adopted a managed float system. The central bank intervenes with floating exchange rate using various policies to maintain the desired exchange rate. The Central Bank provides money if exchange rates are dropping to bring it up again. This is the present status of our foreign exchange policy.