Balance of Payments & Foreign Exchange: Accounts, Rates & Nepal’s System

Core Concepts & Definitions

1. Balance of Payments (BoP): The Nation’s Financial Ledger

The Balance of Payments is a systematic record of all economic transactions between Nepal and the rest of the world over a specific period (usually a fiscal year). It is divided into three main accounts:

graph TD
    A["Balance of Payments"] --> B["Current Account"]
    A --> C["Capital Account"]
    A --> D["Financial Account"]
    B --> B1["Goods & Services"]
    B --> B2["Income (Investment Returns)"]
    B --> B3["Current Transfers"]
    C --> C1["Capital Transfers"]
    C --> C2["Acquisition/Disposal of Non-Produced Assets"]
    D --> D1["Direct Investment"]
    D --> D2["Portfolio Investment"]
    D --> D3["Reserve Assets"]

Key Features:

• Double-entry system: Every credit (inflow) has a corresponding debit (outflow).
• Statistical discrepancy: Adjusts for errors/omissions (e.g., unrecorded remittances).
• Nepal Rastra Bank (NRB) publishes BoP data annually (e.g., NRB’s 2023/24 report).

2. The Three BoP Accounts Explained

A. Current Account (CA)

Records trade in goods/services, income, and transfers (most volatile for Nepal). Components:

Worked Example: Nepal’s 2023/24 Current Account (Simplified) Source: NRB data (Rs. in million)

| Particulars                     | Credit (Rs. Cr.) | Debit (Rs. Cr.) | Net (Rs. Cr.) |
|---------------------------------|------------------|-----------------|---------------|
| **Goods**                       | 1,200,000        | 2,500,000       | -1,300,000    |
| **Services**                    | 400,000          | 300,000         | +100,000      |
| **Income (Remittances)**       | 1,800,000        | 200,000         | +1,600,000    |
| **Current Transfers**           | 500,000          | 100,000         | +400,000      |
| **Total Current Account**       | **3,900,000**    | **3,100,000**   | **+800,000**  |

Interpretation:

• Nepal’s current account surplus (Rs. 800M) means inflows (remittances, services) exceeded outflows (imports).
• Trade deficit (Rs. 1.3T) is offset by invisible earnings (remittances, tourism).

B. Capital Account (KA)

Records one-time transfers of capital (rare in Nepal’s BoP). Components:

• Capital transfers: Debt forgiveness (e.g., China writing off Nepal’s loan).
• Acquisition/disposal of non-produced assets: Sale of patents/land rights.

Example: If Nepal sells a hydropower license to a foreign firm for Rs. 500M, it’s a credit in the capital account.

C. Financial Account (FA)

Tracks long-term investments and reserve changes. Components:

Worked Example: Ncell’s FDI in Nepal

• Scenario: A Singaporean firm invests Rs. 2 billion in Ncell’s 5G expansion.
• BoP Entry:

  | Account               | Particulars                     | Amount (Rs. Cr.) | Dr/Cr |
  |-----------------------|---------------------------------|------------------|-------|
  | **Financial Account** | Direct Investment (Ncell)       | +200             | Cr    |
  | **Capital Account**   | Foreign Equity Inflow          | +200             | Cr    |
  

• Impact: Increases Nepal’s foreign exchange reserves (via Ncell’s future profits).

In the Real World

1. eSewa & Khalti: Foreign Exchange in Daily Transactions

• Idea Used: Spot Exchange Rate (real-time NPR/USD conversion).
• How?
  • When you book a hotel in Thailand via eSewa, the app converts NPR to THB using the interbank rate + 2-3% markup.
  • Example: If NPR 150 = USD 1 (spot rate), eSewa charges NPR 155 for USD 1 (includes their fee).
• Nepal’s Role: NRB sets reference rates daily (e.g., NRB’s FX rates).

2. Daraz & NEPSE: Portfolio Investment Flows

• Idea Used: Capital Account (Portfolio Investment).
• How?
  • If a Singaporean fund buys Rs. 500M worth of NEPSE shares (e.g., NMB Bank, Global IME), it’s recorded as:

    | Account               | Particulars                     | Amount (Rs. Cr.) | Dr/Cr |
    |-----------------------|---------------------------------|------------------|-------|
    | **Financial Account** | Portfolio Investment (NEPSE)    | +500             | Cr    |
    | **Capital Account**   | Foreign Institutional Investor  | +500             | Cr    |
    

  • Impact: Increases liquidity in NEPSE, but also exposes Nepal to capital flight risks if investors withdraw suddenly.

3. NTC & Ncell: Foreign Direct Investment (FDI)

• Idea Used: Financial Account (Direct Investment).
• How?
  • NTC’s fiber-optic expansion funded by a Japanese firm (e.g., NEC Corporation) counts as FDI.
  • BoP Entry:

    | Account               | Particulars                     | Amount (Rs. Cr.) | Dr/Cr |
    |-----------------------|---------------------------------|------------------|-------|
    | **Financial Account** | Direct Investment (NTC)         | +1,200           | Cr    |
    | **Capital Account**   | Foreign Equity Inflow          | +1,200           | Cr    |
    

  • Real-World Link: NTC’s undersea cable project (with China’s Huawei) improved Nepal’s internet connectivity but also raised debt sustainability concerns.

3. Exchange Rates: Types and Systems

A. What is an Exchange Rate?

The price of one currency in terms of another. For Nepal:

• NPR/USD: How many Nepali rupees you get for 1 US dollar.
• Determined by: Supply/demand in foreign exchange (FX) markets.

B. Types of Exchange Rate Systems

C. How Exchange Rates Work: A Kathmandu Retailer’s Story

Scenario: A Kathmandu shop imports iPhones from China (USD 1,000 each) and sells them for NPR 180,000.

Visual Impact of Depreciation:

pie
    title NPR Depreciation Impact on Retailer
    "Profit (NPR 150/USD)" : 30000
    "Profit (NPR 160/USD)" : 20000
    "Loss if NPR 170/USD" : -20000

Key Takeaway:

• NPR depreciation → Imports become expensive → Retailers’ margins shrink.
• NPR appreciation → Exports (e.g., cardamom) become costlier → Trade deficit worsens.

4. Foreign Exchange Market in Nepal

A. Key Players

B. How FX Trading Works: A Mermaid Flowchart

flowchart TD
    A["Exporter (e.g., Cardamom Farmer)"] -->|"Sells to India"| B["Receives USD"]
    B --> C["Deposits USD in NMB Bank"]
    C --> D["NMB Bank sells USD to NRB"]
    D --> E["NRB adds USD to Foreign Exchange Reserves"]
    E --> F["NRB issues NPR to NMB"]
    F --> G["NMB gives NPR to Exporter"]
    H["Importer (e.g., Daraz)"] -->|"Needs USD"| I["Buys USD from NMB"]
    I --> J["NMB uses its USD reserves"]
    J --> K["If reserves low, NMB borrows from NRB"]

Real-World Example:

• NTC exports electricity to India → Receives USD → Deposits in NMB Bank → NMB sells USD to NRB → NRB issues NPR to NMB → NMB pays NTC in NPR.
• Daraz imports goods from China → Needs USD → Buys from Standard Chartered Nepal → Bank uses its USD reserves or borrows from NRB.

5. Foreign Exchange Reserves: Nepal’s Safety Net

A. What Are FX Reserves?

Assets held by NRB (mostly USD, EUR, gold) to:

1. Stabilize NPR (intervene in FX markets).
2. Service external debt (e.g., loans from ADB, World Bank).
3. Meet BoP deficits (e.g., import payments).

Nepal’s FX Reserves (2023/24):

• Total: ~USD 10 billion (≈ 10% of GDP).
• Breakdown:

  | Asset Type       | Amount (USD Billion) | % of Total |
  |------------------|----------------------|------------|
  | Foreign Currency | 8.5                  | 85%        |
  | Gold             | 1.2                  | 12%        |
  | SDRs*            | 0.3                  | 3%         |
  *Special Drawing Rights (IMF asset)
  

B. Why Are Reserves Important?

• Case 1: If NPR depreciates sharply, NRB sells USD to buy NPR and stabilize the market.
• Case 2: If imports surge (e.g., post-COVID demand), reserves fund the deficit.
• Case 3: Debt servicing: Nepal owes USD 12 billion to China/India → Reserves ensure timely payments.

Worked Example: NRB’s Intervention During NPR Crisis (2020)

• Scenario: COVID-19 → Remittances drop → NPR falls to NPR 120/USD.
• NRB’s Action:
  1. Sells USD 500M from reserves → Injects NPR into market.
  2. Rate stabilizes to NPR 110/USD.
• Cost: Reserves drop from USD 10B to USD 9.5B.

6. Foreign Direct Investment (FDI) vs. Portfolio Investment

Real-World Link:

• Ncell’s FDI from Singapore Telecom helped expand 4G but also led to debt concerns when the firm took loans.
• NEPSE’s FIIs (e.g., Singaporean funds) boost liquidity but withdrew Rs. 20B in 2023 during market volatility.

Exam Tip: How to Score Full Marks

1. BoP Questions (40% Weight)

• Must mention all 3 accounts (Current, Capital, Financial).
• Use real data: Cite NRB reports (e.g., "Nepal’s current account surplus of Rs. 800M in 2023").
• Double-entry rule: For every credit, show a debit (e.g., exports → credit; imports → debit).
• Avoid: Saying "BoP is balanced" unless the numbers actually balance (they rarely do—include statistical discrepancy).

2. Exchange Rate Questions (30% Weight)

• Define clearly:
  • Fixed rate: "NPR pegged to USD at NPR 150/USD (as in 2000s)."
  • Floating rate: "NPR determined by market forces (since 2007)."
• Compare systems in a table (like above).
• Real-world link: Relate to NPR depreciation (e.g., "If NPR falls, imports like petroleum become expensive").

3. FX Market & Reserves (20% Weight)

• Explain NRB’s role: "NRB acts as the lender of last resort for banks needing USD."
• Worked example: Show how a trade deficit affects reserves (e.g., "If imports exceed exports by Rs. 500B, NRB must sell USD 3.3B to fund the gap").
• Avoid: Saying reserves are "infinite"—always mention USD 10B limit.

4. FDI vs. Portfolio Investment (10% Weight)

• Use Nepal examples:
  • FDI: "NTC’s undersea cable project with China."
  • Portfolio: "Foreigners buying NMB Bank shares on NEPSE."
• Risk analysis: "FDI is stable but slow; portfolio investment is volatile but quick."

Practice Question with Solution

Question: "Nepal’s Balance of Payments for 2023 shows a current account deficit of Rs. 200 billion, a capital account surplus of Rs. 50 billion, and a financial account surplus of Rs. 100 billion. Explain how these transactions are recorded, and what is the overall BoP position?"

Solution:

1. Current Account Deficit (Rs. 200B Debit):

   | Particulars               | Dr (Rs. Cr.) | Cr (Rs. Cr.) |
   |----------------------------|--------------|--------------|
   | Imports (Goods/Services)   | 2,500,000    |              |
   | Exports                    |              | 2,300,000    |
   | **Net Current Account**     | **200,000**  |              |
   

2. Capital Account Surplus (Rs. 50B Credit):

   | Particulars               | Dr (Rs. Cr.) | Cr (Rs. Cr.) |
   |----------------------------|--------------|--------------|
   | Foreign Aid (USAID)       |              | 50,000       |
   

3. Financial Account Surplus (Rs. 100B Credit):

   | Particulars               | Dr (Rs. Cr.) | Cr (Rs. Cr.) |
   |----------------------------|--------------|--------------|
   | FDI (Ncell Expansion)      |              | 60,000       |
   | Portfolio Investment (NEPSE)|              | 40,000       |
   

4. Overall BoP Position:

   Net BoP = Current (200B -) + Capital (50B +) + Financial (100B +) = **-50B**
   

   Interpretation:

   • Nepal’s overall deficit (Rs. 50B) means outflows exceeded inflows.
   • NRB must use reserves to fund this gap (or borrow from IMF/World Bank).

Exam Tip:

• Always show the double-entry (Dr/Cr columns).
• Link to real-world: "This deficit explains why NRB’s FX reserves fell from USD 10.5B to USD 10B in 2023."