Soaring inflation and a strong dollar are adding to Nepal’s economic woes

INFLATION IS RUNNING AT A NEAR 6-year high of 7.9% in Nepal, compared with 3.65% in May last year. But most people think it is even higher. Shortly, petrol prices shot up by more than 40% at the pump in the year to June 19th. Since then, it has fallen to about 29%. Likewise, costs of everything from cooking oil, bus fares to haircuts, eggs have climbed by more than 5%.

All this is aggravating the pre-existing grievances of city folk (66% of the country's population) who, unlike rural folk that travel less and grow their own crops, spend nearly 35% of their budget on food and transportation.

Not all forms of inflation are painful, because consumers can always delay a purchase. For example, someone looking to own a car may wait until car prices come down. But you cannot stop eating or going to work when their costs rise. So soaring food and fuel prices are the most disgraceful. This sets to erode living standards by reducing consumers’ purchasing power. Even wealthy individuals, usually shielded from scorching inflation, are feeling the pinch. 

The main driver behind the accelerating fuel prices is the price of crude oil, a raw material used for making petrol and diesel. Its price has spiked, as the pandemic faded. During the Covid pandemic, demand for energy fell sharply because many businesses, factories temporarily halted their operations and commuters stopped going to work. In 2020 the price of oil traded below zero briefly. As the world returned to normal, the demand for fuel started outstripping the supply–hiking fuel prices. Like every other commodity, how much you end up paying for petrol or diesel boils down to supply and demand. When the equilibrium of the two is disrupted, you get price swings. And that equilibrium gets determined in international markets for oil and petroleum products. 

Though fuel prices were already rising, the Russian invasion of Ukraine led to a jump in prices further. Russia, the second largest producer in the world, produces one in 10 barrels of oil worldwide. Since the Ukraine war began, its oil supply to the global market has been crimped because of sanctions imposed by major western and eastern countries. This, in turn, has reduced global supplies and contributed to the spike in prices. The problem is so serious that even oil-rich countries, such as Saudi Arabia and the United Arab Emirates, cannot quickly fill the supply gap because oil companies there laid off workers during the pandemic slump. Until supply starts catching up with demand, or demand for energy falls, prices at the pump will likely stay elevated.

Nepal gets its oil supply from India. But even as India is importing more than 760,000 barrels of Russian oil at a steep discount, petrol and diesel prices in Nepal remain some of the highest in South Asia. To give you an idea about how expensive fuel prices have become, consider this: in June the cost of importing fuel rose by more than 75%, year-over-year. To some extent, the high import cost is also a result of growing demand for energy.

You would be forgiven for thinking that Nepal is suffering alone from deteriorating economic conditions such as uncontrollable inflation. Even outside Nepal, inflation is running riot. In America, consumer prices climbed by 8.3% in April from a year earlier. Japan saw an increase of 2.5% in consumer prices in the year to April. Inflation in India is set to exceed 6% this year, compared with 5.5% the previous year. In May inflation in the Eurozone touched a record high of 8.1%.

Central banks around the world, including America’s Federal Reserve, have started tightening financial conditions by raising interest rates to fight back the worst inflation in decades. On May 4th the Federal Reserve raised interest rates by half a percentage point, the biggest increase since 1994. As a result, the US dollar is up by nearly 12% against a basket of currencies over the last year. On June 14th the Nepali rupees plunged to an all-time low of 125.16 against the dollar. According to the Nepal Rastra Bank, the Nepali rupees depreciated by 3.71% between mid-July 2021 and mid-May 2022.

The fallout
That is worrying because it risks adding to Nepal’s debt and inflation woes. The dollar is the world’s reserve currency and is used for buying commodities in the global economy, paying international debt and so on. Nepal depends on food and fuel imports. So expenditure on imports of food and fuel is set to increase at a time when the country’s public finance is already weak. The trade deficit will inflate as the strong dollar raises import bills. It surged by 24.9% in mid-May, year over year. In the same period the country’s export earnings was NRs 173.35 billion, while import bills stood at NRs 1.60 trillion. The cost of servicing dollar-denominated debts will increase, too. It is estimated to have risen by about NRs 19.37 billion in the 3Q. All this will further add to the economic woes of the country. 

Rising interest rates in America and Nepal (inter-bank rate rose to 6.99% in mid-May from 4.12% a year earlier) and soaring prices will sap the government revenue and make it hard for the government to ease the pain even if it wants to. The government is already indebted and short of cash, because of Covid-19 which battered the public finance. 

Galloping inflation and rising interest rates will eat into Nepal’s economic growth. It has fueled a monthslong rout in the stock market, too. Stock prices have tumbled a lot, because of deteriorating macroeconomic indicators–saddling retail investors with steep losses. In the year to July 1st the Nepse Index declined 27.41%. More pain and volatility is ahead, because the central bank will raise interest rates to try to subdue inflation by slowing demand. 

The World Bank recently cut its growth forecast in developing economies from 4.6% to 3.4% this year. “We see a worse situation coming”, Dipendra Bahadur Kshetry, former Governor of the Nepal Rastra Bank, told the Kathmandu Post.