Author

Mahesh K. Chaulagai, Ph.D.

Abstract

This paper attempts to explore the J-curve phenomenon in the case of Nepalese foreign trade
sector in order to examine whether devaluation2 of Nepalese currency can be taken as a policy
tool for improving Nepalese trade imbalance with the rest of the world economies. Johansen’s
cointegration test, vector autoregression (VAR) model, impulse response function as well as
autoregressive distributed lag (ARDL) bounds testing cointegration approach has been employed
in order to see the relationships between the nominal effective exchange rate index (NEER) and
trade balance (TB) as well as the real effective exchange rate index (REER) and trade balance
(TB) of Nepal. The study found no evidence of “J-curve” in the case of Nepalese trade. On the
contrary to the “J-curve” phenomenon as explained by the classical text books, the findings of the
study suggest that depreciation of Nepalese exchange rate rather produces a flatter “L-curve”
phenomenon indicating that there is no room for improving Nepalese trade imbalance through a
currency devaluation process.