The fiery spirit, seeking growth, that Nepal once had, has been vanquished by the sheer lethargy of its citizens. We often question why things are the way they are, yet eventually, the culpability is passed on. The suffering individuals face does not go unheard; it is felt nationwide. Every disappointment, every wasted potential and energy is channelled to every citizen of this once great nation, now left out to be preyed on by maggots. Against this sombre backdrop, this pathos-heavy piece presents Nepal’s tightrope position through a macroeconomic perspective—a story of repeating history each year, despite not learning from mistakes over the last twenty-five years.
Economists around the world, sympathising with Nepal, all outline the structural weaknesses and inefficiencies. These sound generic and the prescribed policies utopian. These can only be understood when empathy with the nation is sought. Once comprehended, it sounds like a basic need, with a response similar to when a family is lifted out of poverty after receiving money from abroad. Yes, remittances uplift a household’s living quality. Yet it cannot be that easy to be happy. Sure, people emigrate because they lose hope in the country for their survival. We have always wondered why people cannot find high-paying jobs near the places they grew up, but we have never questioned the macro impact of the incoming money on a country with policies as ancient as its rulers.
Simply put, remittance inflows cause inflation over time. But then again, “what about the families benefitting from it?” or “it is a source of foreign currency for the nation”. These are exactly the causes of the problems that Nepal faces. It is well established that Nepal’s inflation converges with India's simply due to the historical exchange rate peg. However, the inflation-adjusted exchange rate is appreciating. Meaning the real exchange rate is overvalued, leading to deterioration in trade sectors. Why would a small business not import the exact same goods if the prices abroad are lower? While the government is too busy funding sectors that are not beneficial to the economy, the cutthroat international market swallows domestic competition. The prescribed policy: boost the manufacturing sector through evidence-based subsidies to productive industries to boost exports. Yet, the patient refuses to take the medicine.
The country then turns to sell its unskilled and semi-skilled labour abroad, remitting the savings as a survival instinct. In the short term, the country survives, so do the remittance-receiving households and the international reserves. The low private-sector incentive to manufacture, easy money from foreign employment, and the country's lethargy mean it imports most of its consumption goods, worsening the trade balance on a structural level. In the next period, a trend develops to reallocate all resources to sell labour and use the money not to invest in the productive sector but to consume it all. Now we go beyond the traditional narrative, exploring the mechanical workings of how it all happens, giving us a deeper knowledge of the extent to which Nepal suffers in the long run.
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It is widely debated in Nepal: are remittances and exogenous factors, or their magnitudes and timing, determined endogenously? The Exo party claims that remittance inflow is determined by the foreign partner’s economic context. Meaning, say, if the UAE is booming, remittances from the UAE will grow. The Endo group claims that remittances are determined by domestic economic conditions, specifically domestic inflation. Why would the migrant emigrate if not to support the family during periods of high inflation, no matter how much they must struggle abroad? The recent literature pivots toward the endogeneity of remittances, as evidenced by the bi-directional causality between remittances and inflation. Inflation causes remittances, and remittances cause inflation; the timing of consecutiveness can be debated. To see this effect, we must understand how the remittances seep into the price levels.
Once a migrant processes the remittance, the commercial bank receives the dollars and credits rupees to the household’s account while simultaneously selling the dollars to the central bank to fund the credit. These directly increase international reserves and the domestic money supply. Over time, increased liquidity means there is money in the economy for remittance-receiving households to spend, thereby increasing aggregate demand. The increased purchasing power incentivises businesses to raise their mark-ups, leading to a higher cost of living over time.
The relatively higher inflationary settings erode savings. The migrant, seeing this, is compelled to remit more in the next period. Thus, we enter a self-reinforcing loop that leads to bidirectional causality: past values of domestic inflation have predictive power for future remittance inflows, and vice versa. This is the basics of the impact of remittances on the domestic economy. Now we move on to how this mechanism structurally traps Nepal into an import dependence trap.
We have already established that the inflows increase Nepal’s international currency reserves, which maintain Nepal’s Net Foreign Assets (NFA). The literature suggests that an increase in the money supply reduces Nepal’s NFA, indicating an outflow of some sort. However, Nepal’s capital accounts are closed, but the current accounts were liberalised in 1994. This means a Nepali cannot move its capital assets abroad; however, it can import or export goods freely under Nepal Rastra Bank’s guidelines. Thus, the only way for Nepal to relieve its pent-up foreign currency pressure is to import goods from abroad, a process already made easier by the country’s weak manufacturing sector. Now the country is diagnosed with what the world calls a Dutch Disease.
When a country becomes highly dependent on a single source of revenue, its currency appreciates, making the rest of the economy less competitive internationally. Simply put, when the cost of buying a currency rises sharply, the cost of buying goods from that country also rises, prompting buyers to look elsewhere to meet their demand. This is exactly what happened to the Netherlands in the 1960s when it found a large natural gas reserve. By exporting it, they appreciated the currency beyond its productive capacity, hampering their export performances in other sectors.
Globally prescribed medicine for this Dutch disease: using the foreign revenue to invest in productive sectors that strengthen the structural weaknesses, boosting competitiveness internationally. What does Nepal do? We consume it all. The domestic market benefits from cheap imports at the expense of a higher price level.
You may ask what the central bank is doing. Do they not see this happening? Well, the simple answer is yes: they see it happening and try to stop it, but their attempts are futile given the sheer volume of remittances sent each year and the limited policy tools at their disposal. The Nepal Rastra Bank uses: A). Open Market Operations (OMO) – buying and selling government security bonds to manage liquidity. B). Cash reserve ratio – a reserve requirement that every bank must maintain, which they cannot loan out.
These tools are called sterilisation attempts – in which the central bank neutralises the impact of foreign currency on inflation, exchange rates, or interest rates. Over the last 20 years, only one-third of the foreign currency-led liquidity growth in Nepal has been sterilised. This shows the inability of the Rastra Bank to maintain the price level. The crux of a central bank’s job description is maintaining the price level, which the NRB has failed to do over the long run.
Remittances lift households but, at the macro level, compromise export performance, fuel inflation, and produce symptoms of Dutch disease. Nepal is caught between securing foreign reserves and maintaining domestic price stability. This persistent dichotomy defines the tightrope Nepal is walking on.
