The attempts to preserve the Indian rupee reserve in the country is now bordering along desperate measures for the central bank. The rupee crisis has exposed the vulnerabilities of an import dependent country like ours and calls for a reevaluation of our developmental priorities. While all macroeconomic policies need a reality check, there is also a serious need to go back to the basics and discuss some fundamental economic indicators that bricks up to shape the economy. One such indicator is the pegging of the Bhutanese ngultrum to the Indian rupee.
Historically, having the one-to-one “fixed” or “pegged” exchange rate regime has favored Bhutan.
As is the case with Bhutan, countries with pegs are normally known to have weak capital markets and financial regulating mechanisms. In such a scenario, the peg helps create stability in the economy. In our case, it helped stabilize the ngultrum against the much more stable rupee. As India has always been our largest trading partner and donor, the peg made trade and investment between Bhutan and India easier and avoided the complications of working with daily fluctuations. Having a stable ngultrum also gave it the credibility which helped control inflation.
Because of all the above benefits, our bureaucrats, policymakers, and think tanks have always favored to have the peg and we have never even entertained the debate to remove the peg. They were right, until now. The current rupee crisis has thrown all past logics out of the window and calls for a serious debate on whether we should maintain the peg.
Global experience has shown that the peg is very difficult to maintain over a long period of time. Most often than not, a peg sustained over a long period of time has resulted into a financial crisis forcing countries to un-peg and opt for a floating exchange regime. The Mexican financial crisis of 1994-95 and the Asian Crisis of 1997 are typical examples. The Asian crisis and an artificially high fixed exchange rate further caused the Russian Crisis in 1998. In all the three above examples, an illogical attempt to maintain a high value of the local currency to respect the peg resulted into an overvaluation of the local currency. It resulted in severe depletion of the foreign reserve supplies just like the rupee shortage we are experiencing. Such a situation is called a currency crisis.
After the Asian crisis, Thailand was forced to un-peg its currency with the US dollar. The Asian crisis began in Thailand after Thai baht collapsed and the government failed to support its fixed exchange rate as it had run out of foreign currency.
We are not the only country in the region grappling with the economics of having a fixed exchange regime. Nepal has also pegged its currency to the Indian rupee at 1.6 to 1 meaning that Nepali rupee 160 is equivalent to Indian rupee 100 which was last adjusted in 1993.
However, Nepal’s situation is a bit different because its Foreign Exchange Regulation Act 1962 allows the central bank to follow the floating exchange rate regime. This means that despite its freedom to move away from the peg, it has chosen to stick to it because of political and economic instabilities in Nepal which could erode people’s confidence in the Nepali rupee if the peg is removed.
Moreover, over the past few years, the Indian economy has been growing at more than eight percent while Nepal growth rate has is about half of that. This is a much cited reason by experts to retain the peg because the better growth rate of India makes the Nepali rupee also stronger.
Here, Nepal’s argument of respecting the peg with the Indian rupee because India is doing better than them doesn’t apply to Bhutan. In the past five years, we have experienced an average growth rate of 9.82% with a high of 19.7% in 2007 which is much higher than that of India.
Despite being in either extremes of India in the economic growth scale, it is intriguing to note here that both Bhutan and Nepal is skeptic of doing away with the peg. This shows that there is much beyond actual economics to move away from the peg. There is an ardent lack of political will even to attempt it.
Going back to actual economics, the pegging regime comes with a lot of baggage. One never knows the real economic scenario because growth indicators are dictated by the foreign currency – the Indian rupee in our case. The Mundell-Fleming model says that fixed exchange rate system restricts the effectiveness of having an independent monetary policy to achieve macroeconomic stability. In our context, it means that Bhutan cannot use its monetary policy effectively without assistance from the Indian government. Recently, a foreign expert, with support from the UNDP conducted a study in Bhutan and it recommended Bhutan to have an independent exchange rate policy meaning to remove the peg from the rupee. But the central bank and the government were quick to hush up the suggestion.
Global financial experts are of the consensus that while the peg has certain advantages and a floating regime is not without flaws, the latter is a much better regime to value and understand one’s own currency and to facilitate market equilibrium. In light of the current currency crisis, Bhutan is desperately looking for answers and removing the peg may be the best way for the long run. We can begin by debating on it.