Under the Radar: Nepal in turmoil after India’s rupee demonetization

Under the Radar: Nepal in turmoil after India’s rupee demonetization

India’s rupee demonetization is severely impacting Nepal as Nepalis are left without recourse, with everything from pensions to tourism threatened.

India’s decision to remove its largest denomination banknotes from circulation came as a major surprise to both Indians and international observers. By removing its 500 and 1,000 rupee notes, India has removed 87% of the total bills in circulation, leaving New Delhi with some 23 billion worthless notes to dispose of. While the move was aimed at fighting corruption, black money, and other domestic problems, it has created a host of new problems for India’s neighbours, particularly Nepal.

The sudden withdrawal of these notes from circulation has thrown the Nepalese economy into turmoil, as it is heavily reliant on India, with the Nepalese rupee pegged to the Indian rupee at 1.6:1. India’s sudden decision has greatly affected many ordinary Nepalis, threatening economic uncertainty and increasing instability going forward.

India’s decision could not come at a worse time for Nepal, as the Himalayan country is still facing uncertainty following the 2007 overthrow of the monarchy. Nepal’s government is still negotiating the structure of the new state, with discussions on a new constitution ongoing. This uncertainty, combined with the nation’s remoteness, and the lingering effects of the devastating 2015 earthquake has seen GDP growth shrink to 0.5% for 2016. Years of high inflation – reaching 10.24% in 2016 – effectively mean Nepal is facing substantial economic contraction. Combined with the fact that more than a third of the country is unemployed, India’s demonetization severely undermines the few avenues available to Nepalese citizens to sustain themselves.

Ordinary Nepalis hit hardest

Hundreds of thousand of Nepalese citizens work in India as migrant workers, with Nepal receiving $640 million in remittances from its citizens in India in 2016. Much of these remittances, which amount to 2.6% of GDP, are sent home using the now defunct banknotes. Many migrant workers such as Bishnu Pandey have been left hanging by India’s November 8th decision. “I don’t think I am the target [of India’s demonetization] but I became a victim […] I have no money now to return to work and I have no way to pay back debt,” Pandey, 35, lamented to local media.

Pandey, who attempted to deposit $440 worth of rupees, only to be refused, is now unable to repay a $275 loan used to rebuild the family home after the 2015 earthquake. He is in a situation shared by hundreds of thousands of others now unable to deposit their Indian earnings in Nepalese banks, as said banks no longer recognized the defunct bills. Alongside migrant workers, Nepalese students seeking admission to Indian institutions, those seeking medical treatment, pilgrims, and those visiting family in India are also affected. Moreover, thousands of veteran Gurkhas drawing pensions in Indian rupees have seen their payments undermined.

Unlike Indians, Nepalese citizens are not able to exchange or deposit their notes by the December 30th deadline set by New Delhi’s transition plan. The Federation of Nepalese Chambers of Commerce and Industry estimates that some ten billion rupees ($146 million) in defunct notes is held by the informal sector and private individuals – a major loss of savings in a country with a nominal per capita GDP of only $837.

To make matters worse Nepal has banned the use of the new replacement bills until India issues a FEMA notification, as per the Foreign Exchange Management Act. While this is standard procedure, the move only puts Nepal further at the mercy of New Delhi’s schedule, as well as exacerbates the troubling plight of ordinary Nepalese caught in the middle. This is not the first time consumers and investors have faced difficulties regarding the rupee in Nepal, as prior to 2015 India’s 500 and 1,000 rupee notes were banned, a ban only removed after a visit by PM Modi in the same year.

The upset caused by India’s decision has seen both the Nepal Rashtra Bank and the Royal Monetary Authority of Bhutan meet with the Reserve Bank of India in order seek assistance. Nepal’s Prime Minister has also met with Prime Minister Modi to address the issue, although no arrangements have yet been implemented. During Nepal’s previous ban India set up a task force to ease currency exchanges with Katmandu after which the now defunct 500 and 1,000 rupee bills were finally accepted. There are hints that similar efforts may now be beginning, as an inter-ministerial taskforce has been formed by New Delhi to look at the impact on tourists, non-resident Indians, foreign nationals, and persons of Indian descent holding the old banknotes.

Another concern for both Nepal and Bhutan is how banknote demonetization will impact foreign aid from India, as New Delhi allocated 54.9 billion rupees ($798 million) to Bhutan and 300 million rupees ($4.36 million) to Nepal in 2016.

Demonetization threatens unrest, tourism in Nepal

The losses incurred by ordinary Nepalese from India’s demonetization will have serious knock-on effects, especially in a country with severe existing food shortage problems and a lack of other basic services. If Nepal’s government does not step in and aid those who are suffering, the country will likely see an increase in unrest, as citizens express their anger at the government. This is especially worrisome for Kathmandu which houses a government still trying to cement the transition from monarchical rule. Nepal could see violence erupt in the short to medium term as citizens point to a lack of aid from an increasingly corrupt and insular government.

Any instability could seriously damage Nepal’s efforts at economic growth. The country’s tourism sector is particularly at risk as the industry is highly exposed and responsive to political risk. Tourism constitutes Nepal’s largest source of foreign exchange, and if this source diminishes, then it (coupled with stymied remittance rates) will contribute to a major reduction in desperately needed foreign reserves. Still recovering from the 2015 earthquake, the last thing that Nepal’s tourism industry now needs is an upsurge in social unrest.

Whether Nepal can quickly respond to these problems remains to be seen; for now the country faces some Himalayan hurdles.

Under the Radar uncovers political risk events around the world overlooked by mainstream media. By detecting hidden risks, we keep you ahead of the pack and ready for new opportunities.

Under the Radar is written by Senior Analyst Jeremy Luedi.

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Jeremy Luedi

Jeremy is a widely referenced political risk expert and weekly columnist for Global Risk Insights (GRI). Jeremy's writing has been featured in Business Insider, Huffington Post, Nasdaq.com, The Japan Times, MSN Money, and Yahoo Finance. His work also has been quoted and recommended by Time Magazine, Politico, Transparency International, and Greenpeace, among others.