The Reserve Bank of India (RBI) introduced key reforms in October 2025 to internationalise the Indian rupee (INR) and enhance India-Nepal economic relations. These steps aim to ease cross-border trade and investment by expanding INR usage in Nepal and neighbouring countries. The initiatives could transform bilateral trade dynamics and strengthen regional economic cooperation.
Recent RBI Announcements
RBI Governor Sanjay Malhotra announced three major measures. First, authorised dealer banks can now lend INR to non-residents in Nepal, Bhutan, and Sri Lanka for cross-border transactions. Second, Special Rupee Vostro Accounts will be allowed for foreign banks to invest in Indian corporate bonds and commercial papers, beyond government securities. Third, RBI will establish a transparent reference rate for currencies of major trading partners to support INR-based transactions.
Impact on India-Nepal Trade
India and Nepal have maintained a fixed exchange rate of 1.6 NPR per INR for years. This peg has stabilised Nepal’s currency against global fluctuations. Allowing Indian banks to lend INR to Nepalese entities will ease working capital constraints and promote trade. Nepalese industries, often hindered by limited access to institutional credit, may gain from improved financing options. Competitive interest rates from Indian banks will be crucial for realising these benefits.
Challenges in Nepal’s Economy
Nepal’s economy struggles with low industrial growth and limited bank lending. Domestic banks, dominated by large industrial houses, are cautious in financing small businesses. This restricts working capital and supply chain efficiency. Political instability and high unemployment partly stem from these economic challenges. The RBI’s move to facilitate INR lending can help overcome credit bottlenecks and stimulate economic activity.
Trade and Investment Relations
India is a major investor and trading partner for Nepal. Indian firms hold 33% of Nepal’s foreign direct investment, worth around $670 million. Nepal ranks as India’s 17th largest export market, with India accounting for 65% of Nepal’s international trade. Indian exports to Nepal include edible oil, tea, coffee, and jute. Strengthening INR transactions can deepen this interdependence and reduce Nepal’s vulnerability to currency fluctuations.
Potential Multiplier Effects
Using the INR more widely in Nepal can reduce reliance on the US dollar. This may ease foreign exchange pressures and improve Nepal’s current account deficit. The move could encourage joint ventures and value addition within Nepal’s industries. It also opens doors for further economic cooperation on sovereign guarantees, credit frameworks, and risk assessments between the two countries. Nepal Rastra Bank’s response will be vital to harness these opportunities.
Future Prospects
The RBI’s reforms mark a step toward a more integrated regional currency framework. Enhanced INR usage can stabilise Nepal’s economy and promote sustainable trade growth. Both countries may need to align regulatory and compliance mechanisms to maximise benefits. This policy shift could herald a new phase in India-Nepal economic ties, encouraging closer cooperation and mutual development.
Questions for UPSC:
- Discuss in the light of India-Nepal economic relations, how currency internationalisation can influence bilateral trade and regional stability.
- Critically examine the role of central banks like the Reserve Bank of India and Nepal Rastra Bank in managing cross-border financial cooperation and economic diplomacy.
- Explain the concept of currency pegging. What are its advantages and disadvantages? How can it impact trade relations between neighbouring countries?
- With suitable examples, discuss the significance of foreign direct investment in strengthening economic ties between developing countries and its impact on local industries.
Answer Hints:
1. Discuss in the light of India-Nepal economic relations, how currency internationalisation can influence bilateral trade and regional stability.
- Currency internationalisation facilitates cross-border trade by reducing exchange rate risks and transaction costs.
- Use of INR in Nepal lowers dependence on the US dollar, stabilising Nepal’s foreign exchange reserves and Current Account Deficit.
- Improved access to INR credit can ease working capital constraints for Nepalese businesses, boosting trade volume and industrial growth.
- Enhanced INR usage strengthens economic ties, encouraging regional cooperation and political stability.
- Transparent reference rates for partner currencies promote predictable and efficient trade settlements.
- Reduces currency volatility spillovers, contributing to regional financial stability and integration.
2. Critically examine the role of central banks like the Reserve Bank of India and Nepal Rastra Bank in managing cross-border financial cooperation and economic diplomacy.
- Central banks regulate currency flows and maintain exchange rate stability to facilitate smooth trade and investment.
- RBI’s measures to allow INR lending and Special Rupee Vostro Accounts exemplify proactive financial diplomacy to deepen bilateral ties.
- NRB’s role includes adapting domestic regulations and frameworks to leverage RBI’s initiatives effectively.
- Both banks coordinate to manage sovereign guarantees, credit risk, and compliance for cross-border transactions.
- Central banks act as custodians of monetary stability while promoting economic integration and regional cooperation.
- Challenges include balancing prudential norms with developmental goals and managing currency risks.
3. Explain the concept of currency pegging. What are its advantages and disadvantages? How can it impact trade relations between neighbouring countries?
- Currency pegging fixes the exchange rate of one currency to another to maintain stability and predictability.
- Advantages – reduces exchange rate volatility, encourages trade and investment, and controls inflation.
- Disadvantages – limits monetary policy autonomy, can cause imbalances if fundamentals diverge, and risks speculative attacks.
- India-Nepal’s fixed peg (1.6 NPR per INR) stabilises Nepal’s currency, encouraging trade confidence.
- However, peg may mask underlying economic issues and constrain Nepal’s independent monetary response.
- Overall, pegging can enhance bilateral trade by simplifying transactions but requires strong policy coordination.
4. With suitable examples, discuss the significance of foreign direct investment in strengthening economic ties between developing countries and its impact on local industries.
- FDI brings capital, technology, and expertise, boosting productivity and industrial development.
- Indian firms holding 33% of Nepal’s FDI stock ($670 million) illustrate deepening economic integration.
- FDI promotes job creation, skill development, and infrastructure improvements in host countries.
- Encourages joint ventures and value addition, enhancing competitiveness of local industries.
- FDI can reduce trade imbalances by supporting export-oriented sectors and diversifying economies.
- However, risks include dominance by foreign firms and potential crowding out of local businesses if not managed well.
