At the end of the fiscal year 2020-21 in mid-July, Nepal’s foreign exchange reserves stood at Rs1399.03 billion ($11.75billion), sufficient for importing goods and services for 10.2 months. In two months since, the foreign exchange reserves decreased by nearly Rs100 billion to Rs1306.95 billion ($11.14 billion) in mid-September. This is sufficient to sustain the imports of goods and services for just 7.8 months, officials say.

The monetary policy for the current fiscal year 2021-22 has set the target of maintaining the foreign exchange reserves for sustaining the imports for at least seven months. Further depletion of the foreign exchange reserves is now a cause for concern.

“The foreign currency reserves have reached a point where policymakers need to be alert,” said Nara Bahadur Thapa, former executive director of Nepal Rastra Bank. “A further downturn must be stopped.”

Of the various factors, rising imports and declines in tourism due to the pandemic are to blame for the depletion in foreign exchange reserves. Other contributors are falling remittances, limited exports and minimal foreign direct investment.

In the first two months of the current fiscal year, merchandise imports rose to Rs314.52 billion, an increase by 75.9 percent. Though exports marked a 115.4 percent rise to Rs44.04 billion, it is insignificant compared to the import figures, according to the central bank statistics released on Monday.

Similarly, remittance, the largest source of foreign exchange reserves, decreased by 6.3 percent to Rs155.37 billion.

Tourism earnings, meanwhile, stood at just Rs2.7 billion. While foreign direct investment grew 24.6 percent to Rs3.04 billion, the growth is still insignificant amid a massive rise in foreign exchange spending for imports, according to the central bank.

The country posted a trade deficit of Rs270.48 billion in the first two months of this fiscal year.

The surge in imports has continued even in the first three months of the current fiscal year. According to the Department of Customs, imports increased by 63.73 percent to Rs478.52 billion against exports worth Rs65.05 billion which is expected to contribute to further depletion of the foreign exchange reserves.

Foreign exchange reserves are foreign currencies held by a country’s central bank. These may include foreign currencies, bonds, treasury bills, and foreign government securities. Most foreign exchange reserves are held in US dollars.

Currently, the world's largest foreign exchange reserve holder is China, Nepal’s northern neighbour, with more than $3,ooo billion of its assets in foreign currencies. India, Nepal’s southern neighbour with which the country does most of its trade, on the other hand, has its foreign currency reserves worth over $600 billion. Both China and India are the world’s big economies, with their gross domestic products standing at $14,72 trillion and $2.62 trillion, respectively, against that of Nepal at $33.65 billion in 2020, according to the World Bank.

Since tourism badly suffered because of the pandemic, one of the major sources of foreign currencies in Nepal dried up in the last two years. The tourism sector’s contribution to the foreign exchange reserves was over Rs75 billion in the fiscal year 2018-19 and this dropped by 90 percent to Rs7.26 billion in 2020-21.

Amid this, surging imports led to a flight of foreign currency.

“If we don’t have adequate foreign exchange reserves, we cannot win the confidence of domestic and foreign investors,” said Thapa.

Foreign investors can repatriate dividends as per Nepali law but with the country’s foreign exchange reserves diminishing, they may be unable to repatriate the earnings on their investments in Nepal. This situation could discourage foreign investment in Nepal, according to financial experts.

Depleting foreign exchange reserves, particularly as a result of increased imports, has been a cause for the central bank’s concern.

Central bank officials, however, say there is nothing to worry about as yet.

“We have not faced an alarming situation, but it’s true that time has come for certain import control measures,” said a senior official at the central bank on condition of anonymity because he was not authorised to speak to the media.

Basudev Adhikari, former executive director at the central bank, told the Post that reserves coming down to close to the minimum threshold set by the central bank suggests the situation has reached a “critical zone”.

“In such a situation, the central bank should give careful consideration to its foreign payment commitments associated with the letters of credit for the next two to three months,” he said. “If there are large amounts to be paid, then restrictive measures such as quantitative restrictions on certain goods should be taken or the amount of foreign currency allowed to businesses should be reduced.”

Otherwise, according to him, it is not necessary to take restrictive measures because such moves could encourage people to go to the informal market for foreign exchange.

Adhikari, who served at the foreign exchange department of the central bank for two years as director, said that the finance minister’s reported instruction to officials to work towards increasing the revenue “going beyond logic” could prompt traders to make capital flights fearing more taxes at home and such a tendency could affect the foreign exchange reserves.

Authorities have started taking certain measures to control the outflow of foreign exchange in recent weeks.

The Department of Immigration has halved the minimum foreign exchange amount Nepali citizens travelling abroad need to carry with them to $500. The minimum amount to be carried by those—both workers and tourists—travelling to Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, Malaysia, Thailand and South Asian nations has been reduced further to $250.

“Earlier, Nepalis travelling abroad were required to show [to immigration officials at the airport] they had at least $1,000 with them,” Jhanka Nath Dhakal, spokesperson for the Department of Immigration told the Post earlier this month. “The amount has been reduced as per the request of the Nepal Rastra Bank.”

Although the central bank allows Nepali citizens travelling abroad to buy a maximum of $1,500 from banks, most Nepalis usually buy foreign currency less than the maximum limit.

Besides the new rules set by the immigration department, the Ministry of Industry, Commerce and Supplies has halted licence issuance to traders for importing betel nut, peas, peppercorn and dried dates this fiscal year. Businesses and firms are allowed to import these products in limited amounts after the government fixes quota on the imports.

In March this year, the government had allowed the import of these items until mid-July by setting quantitative limits for each item—1,225,290 tonnes for peas, 227,270 tonnes for betel nut, 41,995 tonnes for dried dates and 140,082 tonnes for peppercorn.

But in the current fiscal year, neither import licences have been issued nor quota fixed for these items. Late last month, the Department of Commerce, Supplies and Consumer Protection had written to the central bank asking not to provide any foreign currency to traders for the import of these items.

Thapa, the former executive director at the central bank, said there is a need to take measures to prevent the foreign currency reserves from sliding down further, but he warned against any alarmist policy.

“A mature and indirect policy that can stabilise the situation needs to be taken,” Thapa told the Post. “Drastic and alarmist measures could indicate the country is in deep financial trouble.”

He suggested more indirect measures like control in lending instead of import control measures.

“Surging imports in recent months are also the result of massive lending by banks and financial institutions. The measures to be taken to control excessive lending would be helpful to control the imports too,” he said. “Another option could be hiking duties and taxes on certain luxury items.”