EFFECT OF INDIAN DEMONATISATION ON ECONOMY OF NEPAL

A TERM PROJECT REPORT SUBMITTED TO

DEPARTMENT OF MANAGEMENT STUDIES
OF
INDIAN INSTITUTE OF TECHNOLOGY, DELHI

IN PARTIAL FULFILLMENT OF THE REQUIREMENTS

FOR
THE THREE CREDIT COURSE
IN
MACROECONOMICS (MSL-727)
NOVEMBER 2017

Submitted by: Group 2

Akash Goel 2016SMN6652

Chanchal Banerjee 2016SMN6653
Naveen Kr. Mishra 2016SMN6656
Nitesh Pareek 2016SMN6702

Guided By:- Dr. Amlendu Dubey

Term Project: Effect of Indian Demonatisation on Economy of Nepal

Contents

Abstract.................................................................................... Error! Bookmark not defined.

I. Introduction ......................................................................... Error! Bookmark not defined.

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Term Project: Effect of Indian Demonatisation on Economy of Nepal

ABSTRACT

8 November 2017 has become a historically important date for us (as an Indian), and is
believed to herald a new era of growth for the Individual and that of the entire nation as a
whole. Claims are higher than normal which concludes that it will pave the path for India to
be the Global leader once again.

However for our dearest neighbor, it has ended being the second biggest shock after the one
they felt on 25 April 2015, and even after one year of the former and 2.5 year of the later,
they are still trying hard to recover from both of them.

3 in 4 of our group have been to Nepal, and they found it difficult to differentiate, if they are
roaming in Nepal or in another city of UttaraKhand. No borders, No language barriers and
No currency barrier. We all
were able to use our Indian
currency normally and no
person, in Nepal either
Indian or Nepali, hesitated to
transact in Indian currency
(excluding coins). However
while studying our course in
Macroeconomics, we were
able to deduce that, the
monetary policy is a very important way, with which government controls its country.

Digging further we were shocked to know that Indian currency is not a legal tender for
financial transactions in Nepal, yet in exercise, it if extensively general to be used in all the
parts of the country, be it inside the Terai, hills or the mountain regions, INR is next to Nepali
rupee in Nepal in terms of circulation and its acceptability and it forms one-5th of Nepal’s
overall economic transactions.

With so much acceptance and use, we thought of the day when the Indian Demonetization
happened and based on our macroeconomic concepts, we decided to analyze the then and
current situation in Nepal, and predict the possible future outcomes, because of
Demonetization.

Though not usual in Abstract but we cannot stop here and will proceed a paragraph ahead to
thank our Guide, teacher and Mentor Dr. Amlendu Dubey at this point of time, since because
his rigorous teachings and unique methodology of explanations in our Macroeconomic
course, we were able to develop a mindset, with which we are able to think, in a lateral,
different and rational way, and were able to write a rather unusual project report.

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Term Project: Effect of Indian Demonatisation on Economy of Nepal

INTRODUCTION

The Indian Rupee is broadly in move due to the fact the working population from Nepal
brings with them huge quantity of Indian notes from India in the form of remittances. This is
more common particularly within the bordering Terai location of the country, the Indian
currency is more in use in comparison to the Nepali rupee for exchange and other commercial
transactions with India. The people of Terai visit India for buying or promoting merchandise
across the Nepal-India border for which they use handiest Indian currency. It is to note that in
Chandani and Dodhara VDCs in Mahakali zone, it is really difficult to find the Nepalese
currency since over 95 % of the transactions in these places are done in Indian currency
alone. The case is not very different in most parts of Nepal-India border.

Nepal ranks (145) low on HDI as compared to India (135), which is the reason why Nepali
National trust Indian rupee at least equal to their own Nepali currency if not superior. Also
because of the fact that more goods and services (especially Medical) can be purchased in
India, as compared to Nepal, there is a continuous greed of accumulating Indian currency
among Nepali citizens.

As per the official announcements of the Central Bank of Nepal, approx 34 million worth of
India’s 1000 and 500 Notes were in various banking channels. This unofficial holding of
these notes is still not known, however one single trader of Kathmandu, is believed to have
1000 crores of Indian black money as said by locals.

On banning of Indian Currency, the demand for Nepalese currency suddenly rose to a high.
However it took time for Indian government to form a committee to look into the subject
issue, but in short run Nepal Government was not able to meet the necessary liquidity as
expected by the currency market of Nepal, since there was always a risk of uncontrolled
liquidity in the future, when people will again buy Indian notes from Nepalese notes, at
higher exchange rate leading to severe rise in Inflation in Nepal. Because of non printing and
release of Nepalese currency the condition emerged as that of Monetary squeeze, which
further reduced the GDP of Nepal. We will discuss these issues in detail in this project report.

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Term Project: Effect of Indian Demonatisation on Economy of Nepal

LITERATURE REVIEW:-

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Term Project: Effect of Indian Demonatisation on Economy of Nepal

METHODOLOGY:-

1. We have searched various articles and news related to the subject.

2. We had in depth analysis of data as published by Nepal Rastra Bank on its Website,
and tried to figure out the vulnerabilities in it.
3. We have studied the Aggregate Demand and Aggregate Supply curve, and tried to
match our findings of the data in point 2 with the literature.
4. We have discussed with some our Nepali friends in our close vicinity and tried to
figure out if our outcome from the project matches the exact situation in Nepal.

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Term Project: Effect of Indian Demonatisation on Economy of Nepal

ANALYSIS:-

It may be noted that, the Indian currency notes of Rs. 500 and Rs. 1000 denominations were
banned in Nepal until 2014 on the request of Indian Government, which eventually has to
change its position because of this the growing hassle of counterfeit notes from Nepal to
India. However the ban was removed in Aug 2015 and this allowed people, coming from
India to Nepal, to hold with them the Indian currency notes of Rs. 500 and Rs. 1000 up to a
maximum of Rs. 25000. However it is argued that the total Indian currency is 20% of the
total currency in circulation. As seen from the CPI in Exhibit 1. There has been a sharp
decline in the CPI of Nepal in the Indian Demonetization year of 2016 till now (Please note
data has been taken as average of 11 months, since CPI is calculated on monthly basis.
Exhibit 1

We also see a sharp decline in the GDP figures of Nepal in the Indian demonetization year of
2016, in Exibit -2
Exhibit 2

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Term Project: Effect of Indian Demonatisation on Economy of Nepal

When we try to explain it using the AD-AS curve, we found that complete literature is able to
define these series of Event using the said model.

Nepal Economy was at Equilibrium A before Indian

demonetization, however following Indian
Demonetization the money supply fell drastically in
Nepal, and there was huge demand of Nepalese currency
for currency, however Nepal Rastra Bank didn’t reacted
(since they considered that total currency in circulation
was on 3 crores of Indian rupee). It is also evident from
Exhibit 3 and Exhibit 4 that Nepal Rastra Bank did nothing to increase the money supply.

Exhibit 3

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Term Project: Effect of Indian Demonatisation on Economy of Nepal

They also kept all the parameters affecting money supply same, rather than trying to control
the monetary squeeze.

Exhibit 4

These has resulted in shifting of LM curve to left on IS-LM model for the economy, which
resulted in shifting of the AD curve to left on AD-AS
model as explained in figure below.

This clearly suggests that it was strongly required that

the interest rate may have been reduced so as to
maintain the liquidity avoid this shifting of LM Curve,
(since people will pull money out of Banks because of
reduced interest rates. However Nepal Rastra Bank
didn’t changed the interest rate either. This is evident
from Exhibit 5 where most of the instruments of central bank to change interest rates are left
untouched.

Exhibit 5

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Term Project: Effect of Indian Demonatisation on Economy of Nepal

Because of shifting of LM curve to left, its direct impact came on Aggregate Demand (AD)
curve which shifted to left on AD-AS curve as shown
in the figure below.

As a result of shifting of AD curve from AD 1 to AD

2, GDP decreased from YN to Y2, which is again
evident in Exhibit 2, and fall in Prices from P1 to P2 is
evident in Exhibit 1. The decrease in saving is also
evident from the Exhibit 6, while the rate of growth
(Although positive) of GNI is also very low compared
to previous years.

Exhibit 6

However the Government is showing interest to revive its economy by increasing

Government consumption (small circle in
green in Exhibit 6), which will eventually
result in shifting the IS curve right, which will
again shift the AD curve back to right so as
to come to help the economy to come at an
equilibrium.

This complete phenomenon resulted in

shifting of SRAS curve from SRAS1 to
SRAS2, leading to a rise to GDP from Y2 to
YN with price permanently falling from P2 to P3, and thereby bringing the economy back to
the equilibrium level C.

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Term Project: Effect of Indian Demonatisation on Economy of Nepal

However in Exhibit 7 we also see a positive effort of purchasing less Nepali Rupees in
comparison to what they have done in the preceding year, because of severe loss of output
and reduction in prices we assume that this step is not powerful enough to reduce the effect of
Indian Demonitization on the economy of Nepal.

Exhibit 7

On further digging up as in Balance of Payments in Exhibit 8 we can easily see that Nepal
has actually funded a part of Indian demonetization thought its Reserves; in another words,
Indian demonetization resulted in eroding of Nepal reserves as evident in Exhibit 8.

NRB kept anticipating that an Indian team will come back to Nepal by February 22, 2017 to
facilitate the alternate of banned Indian notes of Rs. 500 and Rs. 1000. But India kept
unscrupulous elements in India might convey to Nepal about banned notes they have got and
get them exchanged into new notes. This is additionally one of the factors why there is so the
development of positive mechanism to change old currency into New ones has been
postponed in Nepal.

Nonetheless, after one complete year of demonetization certain agencies of are still hopeful
that some mechanism of exchanging the Indian currency Notes will be designed by Indian
government which will help the economy of Nepal to get a much needed Boost

This argument is again countered by the fact that many Nepalese – be it in the hills, mountain
or the Terai regions – had in one way or the other have managed to exchange all of their old
currency notes into new ones, using the facility of free movement allowed to Nepali citizens
in india via their contacts or family members. Another counter argument comes from the RBI
announcement where most of the circulated currency has come back to the Banking system in
India.

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Term Project: Effect of Indian Demonatisation on Economy of Nepal

Exhibit 8

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Term Project: Effect of Indian Demonatisation on Economy of Nepal

CONCLUSION:-

We believe that sentiments are responsible for driving the economy; however the policy
makers are required to stay away from sentiments and should take rational decisions, which
are important in the National Interest.

In the case we see a sentimental and a wait and watch approach of NRB, where despite
knowing the truth that, huge Indian currency was circulation in Nepal, denied it summarily
and designed all the ways to get it own cash reserves of 4 crores of Indian currency to be
converted to New Currency.

If NRB was rational in understanding the truth, they would have minimized the affect of
Indian Demonetization on its own economy, by increasing the Money supply and reducing
the interest rates.

However its smaller counterpart handled the crisis in a much smoother way owing to
perception of Indian Government to be of lesser security risk when compared with Nepal.
They collected Indian Currency Notes from the very beginning but for much shorter period to
avoid the facility being misused; till 30th of November 2016, which was later exchanged not
only in coordination with Indian government but also by Bhutanese government in the way of
sending its own officials to withdraw cash in smaller denominations from the border areas in
India.

A draw was held to choose lucky 50 (later increased to lucky200) who could get Rupees 5000
in single shot. Since the trust component is high in Bhutanese people, they devised a token
system of transaction for few days, where the token with signatures of head of the village,
was accepted as a medium of exchange of goods and service, which was later exchanged with
new currency.

We as an Indian believe; that Demonetization was done to remove the Illegality and
irregularity which might have crept in the Indian economy owing to 70 years of
independence. The situation in Nepal has risen because of the fact that though not a legal
tender for financial transaction, Indian currency was widely used in Nepal, and if Nepalese
are not able to do the same easily after demonetization, than we suppose that one of the
purposes of Demonetization has been successfully fulfilled by Indian government. As far as
Nepalese economy is consider it will surely recover, since fundamentals of a country doesn’t
change overnight.

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Term Project: Effect of Indian Demonatisation on Economy of Nepal

REFERENCES

1. http://www.hindustantimes.com/world-news/rs-500-100-notes-being-illegally-
exchanged-at-nepal-india-border/story-sMDe2sYgVnhozJphA6yVxM.html

2. https://thewire.in/195561/where-do-nepal-and-bhutan-stand-one-year-after-
demonetisation/

3. https://nrb.org.np/ofg/monetary_policy/Monetary_Policy_(in_Nepali)--2017-
18_(In_English)_(Full_Text)-new.pdf

4. http://www.orfonline.org/expert-speaks/demonetisation-of-indian-currency-and-nepal/

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