In a surprise decision on 13 December, the Government of Nepal declared a ban on the circulation of high-value Indian currency in the denominations of Rs 200, 500 and 2,000.

The move comes more than two years after Prime Minister Narendra Modi announced the demonetisation of Rs 500 and 1,000 notes in India on November 8, 2016. However, India was not the only country affected by the exercise. Two neighbours - Nepal and Bhutan - also faced difficulties as the Indian currency was widely in circulation there as well.

After the announcement, a big chunk of the demonetised notes were stuck in these countries. A quickfire solution for the exchange of currency was worked out with Bhutan. However, despite several rounds of discussions between India and Nepal, no solution has been reached there till date.

According to unofficial reports, demonetised notes worth an estimated Rs 950 crore are stuck in the Nepalese market. The official estimate of the Nepal Rastra Bank puts the figure at Rs 33.6 million. Even though Indian currency is circulated in the open market in Nepal, the circulation remains under an informal understanding between the two governments. Therefore, the process for exchange becomes evolving rather than agreed, leading to further delays.

In the past two years, the issue of currency exchange has been top of the agenda during visits to India by Nepalese officials, including the prime minister. A major discussion took place during Finance Minister Arun Jaitley’s visit to Kathmandu last year. Jaitley had assured early facilitation for the exchange of demonetised currency and promised that the Reserve Bank of India (RBI) would set up a modality to ease the difficulties faced by Nepalese citizens. However, the reality on the ground remains complex as ever.

Meanwhile, the finance ministry and the RBI have raised concerns over the circulation of counterfeit Indian currency in Nepal. Since Nepal has been a major gateway for counterfeit currency into India, an exact figure of authentic demonetised Indian currency remains opaque. On a number of occasions, due to the open border, counterfeits printed in Pakistan have been circulated into India through Nepal. Hence, it is not only a question of the monetary challenge before India but also a security challenge before the Indian security establishment due to the possible procurement of Indian currency by terror groups for funding and organising their acts.

Soon after demonetisation, the Nepal Rastra Bank had cautioned its citizens not to keep newly issued Indian currency notes of Rs 200, 500 and 2,000 denominations. However, considering the large number of migrant workers coming to India for short-term employment, it is an impossible task. A large chunk of Indian currency reaches Nepal through informal channels, mostly in larger denominations. So, controlling the currency circulation is a challenge for both countries.

The ban on high-value Indian currency will surely have an immediate impact on Nepal.

For starters, the ban will have direct implications for small- and medium-level traders. A number of commodities, especially spices, sent from Nepal to India are traded in higher denominations. Therefore, the spice market may dry up due to the lack of circulation of high-value notes into Nepal.

Nepal receives a large number of Indian tourists every year. Being home to several important Hindu and Buddhist religious sites, including Lord Buddha’s birthplace Lumbini, Nepal received nearly one lakh Indian tourists (from a total of five lakh foreign tourists in the first half of 2018). Similarly, with 90 per cent of the population being Hindu, many religious tourists from Nepal visit India. While an open border and passport-free mechanism makes life easy for Indian tourists, the open circulation of Indian currency in Nepal also saves them from spending on exchange fees.

In May, Kathmandu announced the launch of the ‘Visit Nepal’ campaign with an aim to attract 2 million foreign tourists by 2020. In this context, the amount of exchange that tourists may require in Rs 100 bills may trigger a severe cash crunch, which might result in a fall in the number of tourists visiting Nepal.

On the brighter side, three-fifths of Nepal’s trade deficit lies with India. Nepal’s heavy trade dependence on India has led to the pegging of the Nepalese currency to the Indian rupee. For the past 25 years, the exchange rate from the Indian currency to Nepalese has been 10:16. Considering the dependence of the Nepalese public on India for employment and business, the pegged currency exchange rate from INR to NPR has been benefiting Nepal in light of its critical economic indicators lately. Yet, in the light of Nepal’s recent entry into the investment market, a pegged ratio may harm its economy in the longer term.

Therefore, a ban on high-value Indian currency may prompt the need for formalising the remittance transfer from India to Nepal, which might eventually minimise the chances of greater economic losses as well as illegal uses of the Indian currency.

To conclude, in the past 20 years of political turmoil and the devastating earthquake in 2015, the Nepalese economy has witnessed serious lows. While the development process in Nepal looks for foreign aid, improving the economic indicators are in pressing need for political will. With these poor economic indicators, the Government of Nepal needs to rethink the currency ban because remittances sent home by Nepalese migrant workers account for 30 per cent of the country’s GDP, followed by tourism with 7.5 per cent. And in both these cases, India plays a crucial role.

Rishi Gupta is a doctoral candidate at the Centre for South Asian Studies, Jawaharlal Nehru University, New Delhi. The views expressed here are personal.