Revisiting Inflation Dynamics in Nepal: Global Geopolitical Risk or Cross Border Price Transmission
Using annual data from 1985 to 2024 and an ARDL framework, this paper finds that while Indian inflation and crude oil prices remain the primary drivers of Nepal's inflation, global geopolitical risk represents an emerging, albeit not yet uniformly robust, transmission channel that warrants monitoring by monetary authorities.
Original paper licensed under CC BY 4.0 (https://creativecommons.org/licenses/by/4.0/). This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer
In the small, landlocked nation of Nepal, the price of bread, fuel, and daily necessities does not move in isolation. Because the country shares an open border with India and ties its currency value directly to the Indian rupee, the economic pulse of its giant neighbor beats in unison with its own. For decades, economists have understood that when prices rise in India, they rise in Nepal. They also know that when the global cost of oil spikes, the cost of living in Nepal follows, simply because the country imports almost all its fuel. These are the established rules of the game: trade flows and currency links act as the primary channels through which inflation travels. But the world has changed in recent years, becoming a place of heightened tension, disrupted shipping lanes, and global uncertainty. A new question has emerged for economists: does this broader global tension, distinct from specific price hikes in oil or India, now have its own direct power to push up prices in Nepal?
A team of researchers from Tribhuvan University set out to answer this question by looking at forty years of economic history, from 1985 to 2024. They wanted to see if a specific measure of global geopolitical risk—a number that tracks the intensity of international conflicts, wars, and political instability—acts as an independent engine for inflation in Nepal. To do this, they gathered data on Nepal's annual inflation rates, India's inflation, the price of Brent crude oil, the exchange rate between the US dollar and the Nepalese rupee, and the global geopolitical risk index. They then used a statistical method designed to find long-term relationships between these moving parts, treating the data like a complex puzzle where each piece must fit together over time to reveal the true picture.
The researchers found that the old rules still hold the most sway. The strongest driver of inflation in Nepal remains the price level in India. When Indian prices go up, Nepalese prices follow with a high degree of certainty, confirming that the open border and currency peg create a direct and powerful transmission line. Global oil prices also play a clear role; when the cost of crude oil rises, it pushes up the cost of transport and production in Nepal, leading to higher consumer prices. The speed at which these prices adjust is remarkably fast. The study shows that if prices drift away from their long-term balance, the economy corrects itself by about ninety-three percent within a single year, snapping back to equilibrium with surprising speed.
The most significant discovery, however, concerns the new variable: global geopolitical risk. The researchers found that while high levels of global tension do tend to be associated with higher prices in Nepal, this relationship is not as strong or as direct as the influence of Indian inflation or oil prices. The data suggests that the effect of global conflict is often indirect. It likely works by first driving up the price of oil or by influencing the Indian economy, which then passes the shock on to Nepal. When the researchers isolated the geopolitical risk factor from these other channels, its independent power to raise prices appeared weak and inconsistent. In some statistical tests, the link was barely noticeable; in others, it showed a faint but positive connection. This indicates that while global uncertainty is a growing concern, it has not yet become a primary, standalone cause of inflation in Nepal in the way that Indian prices or oil costs have.
The study also examined how the exchange rate affects prices. In a typical economy, a weaker currency usually leads to immediate inflation because imports become more expensive. However, because Nepal's currency is pegged to the Indian rupee, the relationship is more complex. The researchers observed that movements in the exchange rate against the US dollar did not always produce the expected immediate spike in prices, likely because the fixed link to India absorbs much of the shock. The model passed every rigorous test for reliability, showing no hidden errors or distortions in the data, and the results held steady even when the researchers used different mathematical approaches to verify them.
Ultimately, the research suggests that for policymakers in Nepal, the most effective way to anticipate inflation is to watch India and the global oil market. While global geopolitical risk is an emerging factor that warrants attention, it does not yet appear to be a separate, dominant force that requires a unique policy response distinct from the existing strategies for managing oil prices and cross-border trade. The economy remains deeply tethered to its regional neighbor and the cost of energy, with global tensions acting more as a background pressure that amplifies these existing channels rather than a new, independent driver of price changes.
Drowning in papers in your field?
Get daily digests of the most novel papers matching your research keywords — with technical summaries, in your language.