Soaring forex reserve: Can it become a stepping stone for long-term development?

KATHMANDU: Nepal’s foreign exchange reserves have swelled to US Dollar $11.65 billion, or Rs 1,402 billion, in mid-July from $9.5 billion (Rs 1,039 billion) a year ago. In one year, the foreign exchange reserves of the country rose by $2.15 billion (Rs 363 billion).

This is the highest amount of foreign exchange reserves that the country has observed in its record. Most of these reserves are held in US dollar which is the most traded currency in the world. The central bank holds the reserves also in other foreign currencies in the form of foreign bonds, treasury bills and other government securities.

So, why has the level of foreign exchange reserves soared to a record high level when most of the other macroeconomic indicators are deteriorating due to COVID-19?

Many analysts attribute the recent surge to the impact of the pandemic. As the government introduced various containment measures including a four-month long nationwide lockdown starting from March 14 to curb the spread of coronavirus, there was a significant decline in international trade. Given that Nepal’s imports are far higher than exports, the country was able to save a significant amount of US dollars that would have been used to make payments for the imports.

According to data of Nepal Rastra Bank (NRB), Nepal’s imports fell 15.6 percent to Rs 1,197 billion in the last fiscal year 2018/19, down from Rs 1,419 billion in the previous fiscal year 2017/18. Drop in the imports compared to an annual average growth of 15 percent helped the country to save Rs 222 billion in payments against the import of goods.

The slowdown in imports could be interpreted as an impact of the lockdown that not only hit the flow of goods but also depressed consumer demand in the market. Some of the measures taken by the government to curb imports of unnecessary luxury goods like vehicles also helped to lower the import bill.

However, the growth of exports remained flat at Rs 97.7 billion. The sharp decline in imports without exports taking a hit helped narrow the trade deficit of the country.

One of the major sources of foreign currency earnings for Nepal is remittances. Against the widespread concerns about the possibility of a sharp decline in remittances due to the economic crisis induced by COVID-19, the total amount of money sent by Nepalis abroad did not fall significantly. The remittance inflow decreased by a mere 0.5 percent to Rs 875.03 billion in the last fiscal year 2019/20. Remittances remained almost unaffected.

Another important source of foreign currency has been spending by international tourists in Nepal. However, the pandemic upended the tourism business. The slump in arrivals of international tourists led to a decline in such earnings by at least Rs 14.49 billion in the last fiscal year, according to the central bank’s report. The travel earnings fell by 19 percent to Rs 60.88 billion in the last fiscal year on the account of a slump in tourist arrivals.

But, the payment for outbound travel including spending on education also dived which helped to balance the service account of the country. The decision of the central bank to lower the limit of foreign currency exchange to $1,500 per passport from $2,500 and $200 for migrant workers along with suspension of international flights in March caused a decline in travel payment in the last fiscal year.

The travel payments that Nepalis took abroad for either vacations or higher studies fell to Rs 53.14 billion in last fiscal year from Rs 89.19 billion. This means that lower travel payments offset the impact that the slump in foreign currency earnings from international tourists could have made on the service account of the country.

Foreign direct investment jumped by 49 percent to Rs 19.48 billion while the government’s international borrowing doubled to Rs 16.26 billion which also helped in increasing the flow of foreign currency in Nepal. When the country was burning through the foreign exchange reserves in the last fiscal year to meet the shortfall in its international payment obligations, the balance of payments remained at a surplus of Rs 282.41 billion.

BREATHER FOR ECONOMY UNDER STRESS

What it means to have such a high level of forex reserves?

The rising forex reserves provide a lot of comfort to the government and the central bank that are now bracing for a slowdown in the economy due to the COVID-19. The foreign exchange reserves provide a big cushion for a country in case it faces an economic or financial crisis and struggles to cover the import bill. While the inflow of remittances—the vital source of foreign currency—has remained robust, the possibility of a sharp decline in remittances continue to haunt the government as global economic outlook still looks uncertain due to the coronavirus.

For an economy like Nepal that is heavily dependent on imports, it needs to have adequate reserves of foreign currency to make sure that it does not have to fret about ways to finance imports for certain months even if foreign incomes dry up suddenly.

FIRST LINE OF DEFENSE

Since international trade was affected due to the lockdown, there will be a sharp rise in the subdued imports after authorities start to relax containment measures. Though the government has been making efforts to mobilize foreign assistance, analysts caution about a significant growth in such support as many countries are themselves reeling under the crisis.

So, the forex reserves become the first line of defense against an economic crisis, particularly an external shock.

According to NRB, the foreign exchange reserves are sufficient to cover the prospective merchandise imports of 14.4 months, and merchandise and services imports of 12.7 months. International Monetary Fund (IMF) and experts say that a country must have foreign exchange reserves to cover at least six months’ of imports.

SOURCE OF CONFIDENCE FOR FOREIGN INVESTORS

Not only do foreign exchange reserves serve as backup fund to finance imports, they are also a major indicator that foreign investors assess before they consider making investments in Nepal, say experts.

If the forex reserves are not adequate, it could deter foreign investors in making investments as they may see risk of capital controls or problems in the repatriation of profits later. Forex reserves provide a level of confidence to investors that a country can meet its external obligations, according to experts.

“As Nepal has adequate level of forex reserves, it would be a positive selling point to attract foreign investors in Nepal,” said a high-level official at the central bank.

STEPPING STONE TO LONG-TERM DEVELOPMENT

The comfortable position that Nepal holds in terms of foreign exchange reserves also promises Nepal the financing need for its long-term development. Many countries reel under the shortage of foreign currency to finance their development and infrastructure projects.

Experts say that the robust level of foreign exchange reserves could become a stepping stone for long-term development.

“The $12 billion reserve that we have is not a small amount. Whether we want to squander this reserve of foreign currency or plan for long-term development from this comfortable position? Whether we should buy consumable goods or encourage machines that produce them? Whether we buy vehicles as a source of government revenue or steer the country toward long-term development by building fast track roads? These are the vital economic questions,” wrote Biswo Poudel, an economist, in a recent Facebook post.