Monetary Integration between India and Nepal

An open border, a pegged exchange rate regime and large trade with India offer Nepal some preconditions to satisfy monetary integration with its southern neighbour. In this study, investigation of the economic symmetry in the two countries is considered. A two-pronged empirical approach reveals inconclusive evidence to satisfy such integration. First, using a three-variable structural vector auto-regression showed a low and negative correlation in the supply shocks. Decomposing the structural shocks into regional and idiosyncratic components showed a favourable co-movement with the regional element only in Nepal’s monetary shock. Second, the business-cycle analysis using state-space models of Nepal’s GDP and its components showed evidence of co-movement with the regional element in some variables while others showed divergence.