The double-edged sword of a weaker currency

The double-edged sword of a weaker currency

Ngultrum depreciation: Impacts and challenges for Bhutan

The depreciation of the Bhutanese Ngultrum (BTN) against the US Dollar (USD) presents both challenges and opportunities for Bhutan, affecting businesses, trade relationships, and debt sustainability. Despite potential benefits for exports, concerns remain about the country’s heavy reliance on India and the cost of servicing foreign currency-denominated debt.

The term depreciation of currency refers to a fall in the currency’s value in a floating exchange rate system where demand and supply determine the value of a currency.

BTN depreciation is the fall in the value of the Ngultrum against the Dollar, implying that the Ngultrum has become less valuable and weaker against the Dollar. For instance, if the value of 1 USD increases from BTN 60 to 65, the change will be termed depreciation of the Ngultrum.

Professor of economics at Royal Thimphu College, Sanjeev Mehta said the impact of deprecation on Bhutanese businesses is very complex. “Given the large trade with India, depreciation against the USD does not have any direct impact, but its impact on India tends to have a slipover effect in Bhutan.”

While the depreciation may not directly impact the large trade relationship with India, it has implications for businesses engaged in direct trade with third countries. “Importing from third countries becomes more expensive due to the weaker Ngultrum, affecting the comparative advantage of export-oriented units,” the professor said.

Maintaining exchange rate pegs with India is deemed crucial, particularly amid depleting convertible currency reserves. The professor suggested that market corrections and interventions by the Reserve Bank of India to mitigate depreciation could assist Bhutan in navigating these challenges.

Despite concerns about the depreciation’s potential impact on FDI inflows and GDP growth, it is noted that such economic indicators may not be significantly affected. However, the depreciation may impact the purchasing power of businesses, prompting them to consider using instruments like currency hedging to manage the crisis and enhance operational efficiency.

The professor said that if businesses are affected by this depreciation, they can mitigate the crisis by using instruments such as currency hedging. “If hedging is not common, firms can absorb the impact by improving their operational efficiency.”

Meanwhile, according to the RMA’s latest data, the Ngultrum depreciated by an average of 24% in 2023, primarily influenced by the US Federal Reserve’s actions and geopolitical tensions. While a weaker Ngultrum could potentially benefit exports, the country’s heavy reliance on India limits the impact on the trade balance.

A more significant concern lies in the report on the debt portfolio. The Nu’s depreciation increases the cost of servicing foreign currency-denominated debt, raising worries about long-term debt sustainability. This is particularly crucial considering the challenges the country faces in generating sufficient foreign exchange earnings.

With the exchange rate development in India, considering the fixed one-to-one peg of the BTN to the INR, there is a direct impact on the confidence of the Nu in the international market. The performance of the Nu in the international markets is intricately tied up with the INR’s performance on the global stage. Further, the annual report declared the Nu’s depreciation against the USD, reaching Nu 82.9 per USD in four quarters in 2023.

While potentially boosting exports, it inflates the cost of essential imports and increases the debt burden, particularly for foreign currency-denominated debt. Notably, the country’s trade balance, heavily reliant on India, accounting for 80 percent, mitigates the direct impact on trade costs.

Meanwhile, the value of Ngultrum at current exchange rate against the USD is Nu 82.8.

By Nidup Lhamo, Thimphu