Depreciating Ngultrum costly on the economy

Given a significant depreciation this year, the debt service and overall debt stock in nominal currency has increased substantially

When the Ngultrum (Nu) depreciates against the USD, it can have direct impact on Bhutan’s trade balance. Starting from the third quarter of 2022, the Nu has been consistently trading around the USD 80 mark. It reached its highest point in the fourth quarter of 2022, with an exchange rate of Nu 82.9 per USD.

Moving into the second quarter of 2023, the Nu has experienced a depreciation of 3.9% compared to the same period in the previous year. When looking at the average exchange rate over the course of four quarters in 2022, the Nu has been depreciating by an average of 2.4%. These depreciations in the Nu aligned to INR illustrate the changing dynamics of the Nu in relation to the USD over the period.

The depreciation of Nu not only increases the debt burden by requiring larger allocation of Nu for debt service obligation by the Royal Government of Bhutan (RGoB), but also raises concerns of debt sustainability in the long run. This particularly stems when the economy faces difficulties in generating sufficient foreign exchange earnings.

Typically, a weaker currency make imports expensive and exports dearer, potentially boosting exports. However, Bhutan’s trade situation is unique due to its strong economic ties with India, which accounts for approximately 80% of the total trade including hydropower exports. Under these circumstances, the depreciation of Nu does not necessarily lead to a more favorable balance of trade for Bhutan. Thus, there is a limited direct impact on the cost of trade for Bhutan in such economic situation.

The depreciation of Nu also has a significant impact on the debt portfolio of an economy, particularly when the debt is denominated in cash credit (CC) such as USD. The INR denominated debt benefits from currency volatility but CC denominated debts is exposed to exchange rate risk. Given a significant depreciation of Nu this year, the debt service and overall debt stock in nominal currency has increased substantially.

As the Nu slightly appreciated in the second quarter of 2023 relative to first quarter, the economy witnessed a decline in the debt impact with the Countries Other Than India (COTI).

The variations in nominal exchange rate signals the amount of domestic currency needed to purchase foreign currency. It does not exactly reveal the true competitiveness of the currency. Thus, it is important to assess its Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rates (REER), which serves as crucial tools for evaluating a country’s economic competitiveness internationally. The NEER focuses on the changes in currency value and the REER provides a more comprehensive view by incorporating price differentials, making it a key indicator of nation’s trade competitiveness by taking account of both exchange rate and relative price levels.

The NEER of Nu has consistently remained stable over the period relative to the currencies included in the basket, fluctuating within a narrow range of 98.2 to 100.1. Unlike the usual scenario where an increase in trade share with trading partners tends to exert upward pressure, it has remained constant. The stability can be viewed from the current exchange rate regime and its heavy reliance on trade with India.

The REER of Nu in contrast has exhibited fluctuation over the period and during certain periods; it appears to closely track the trend of the INR_REER. The decline in BTN_REER in 2022 is largely because of the depreciation of Nu against the basket of currencies and rising inflation among Bhutan’s trading partners.

In the Indian case, (NEER/ REER) moved with a depreciating bias during 2022-23. On an average basis, the 40-currency NEER and REER depreciated by 2% and 1.8%, respectively, during the year, according to the Reserve Bank of India (RBI). Given the largely uncertain global economic outlook, challenges arising from external imbalances are expected to exert significant pressure on exchange rate depreciation.

Meanwhile, as the performance of the Nu is closely tied to that of the Indian Rupee, the RMA will persist in closely monitoring market developments in India and other economies, according to the central bank.

Tashi Namgyal from Thimphu