When Indian Prime Minister Narendra Modi announced in November 2016 the overnight removal of all 500 and 1,000 rupee notes from circulation, it was framed as a crackdown on the black market, illicit money and counterfeit cash. This decision to declare about 86 per cent of the paper money in circulation, by value, null and void was met with both opprobrium and applause at the time. It is still not clear, 27 months later, if it has achieved its stated aims . But demonetisation did succeed in doing something that New Delhi may come to regret – driving a wedge between it and one of its closest allies. Nepal, the mountainous landlocked nation that straddles the high Himalayas between India and China, was particularly hard hit by Modi’s announcement. Its economy, largely driven by tourism and remittances, is closely linked with India’s – millions of Nepalese live and work over the border, sending rupees back home. In April, Reuters reported that individuals and businesses in Nepal were holding on to an estimated US$146 million in worthless rupee bills. About half of that amount is thought to be parked in the country’s central bank. Should India credit Modi’s demonetisation for digital boom? On a visit to New Delhi last month, Nepal’s foreign minister Pradeep Kumar Gyawali said his government was still awaiting “a positive gesture from India” on whether the country’s cache of old notes will be honoured and exchanged. Neighbouring Bhutan is reported to have exchanged 1.2 billion [US$16.8 million) worth of demonetised rupees in May 2017. India is Nepal’s largest trade partner and the supplier of most of its consumer goods. Indian rupees have traditionally enjoyed widespread acceptance in the country, with many Nepalese even keeping their cash savings in the currency. But the lack of assurances from New Delhi, despite several rounds of official talks and Nepalese Prime Minister K.P. Sharma Oli raising the matter personally with Modi in May, appears to be unnerving Kathmandu. In December, Nepal banned the use of all Indian bank notes with a face value greater than 100 rupees. Anil Sigdel, director of the Washington-based think tank Nepal Matters for America, said there was even talk “in some quarters” of “boycott[ing] Indian goods as well”. “This all becomes [a] boon for China. Nepal does want to have a very good relationship with India, but it seems India itself is pushing Nepal north,” he said. LOSS OF FAITH Another knock-on effect has been the erosion of faith in the Indian currency among many Nepalese. Prasad Sharma, a businessman based in India’s West Bengal state, which shares a border with Nepal, said that many of the people he deals with from across the border now refused to take India rupees and had switched to digital transactions or bank transfers instead. Digital payments are expected to hit US$1 trillion in India by 2023, from less than US$200 billion last year, according to a report by investment banking group Credit Suisse. Sharma described India’s decision to demonetise as “a nightmare”. “We couldn’t even pay our employees at that time since the workers prefer their salaries in cash,” he said. For Bhim Bhurtel, former executive director of the Nepal South Asia Centre think tank in Kathmandu, India’s stonewalling over the currency issue could leave its ally feeling betrayed. “If India exchanged at Nepal’s first request, then Nepal would feel that India is sensitive to [its] neighbour’s concerns,” he said. “[But] if you repeatedly overlook the request of your friend, then your friend definitely feels a sense of betrayal.” Bilateral relations have suffered setbacks in the past. In 2015, Nepal accused India of imposing a blockade that drastically cut supplies of fuel and other essentials to the landlocked nation. New Delhi denied the allegations, pointing the finger instead at separatist protesters within Nepal. China scores as Nepal plays hardball with India over border ‘blockade’ With almost all of Nepal’s imports coming via its southern neighbour, connectivity and infrastructure are continual sticking points as well. Cross-border cargo movements often suffer from the poor state of roads on the Indian side of the border and while progress is being made on new railway links, during his recent visit Gyawali pointedly asked his Indian counterpart Sushma Swaraj to fast-track work on a new line between Kathmandu and the border town of Raxaul. ENTER THE DRAGON China, meanwhile, is making its own moves. In June, during a visit to Beijing by Oli, the Nepalese prime minister, the two sides sealed eight deals worth US$2.4 billion , dominated by connectivity, infrastructure and energy projects – including a 628km cross-Himalayan railway linking China to Kathmandu. Once fully operational, Nepal expects as many as 2.5 million Chinese per year to use the railway – which could also help boost trade links between India and China. Within the next few months, Chinese President Xi Jinping is expected to visit the Nepalese capital to sign an agreement that will allow Nepal to conduct trade through Chinese ports. The final draft of the Nepal-China Transit and Transportation Agreement covers Tianjin, Shenzhen, Lianyungang and Zhanjiang, as well several inland ports such as Lhasa, with the option of including additional ports in future. “Unlike [its] soft approach in the past, China is [now more] forthright and forthcoming in Nepalese affairs,” said Mahendra Lama, a specialist on regional cooperation and integration from Jawaharlal Nehru University. Recent Beijing-backed infrastructure projects under its massive “ Belt and Road Initiative ” have been “transformative” for Nepal, Lama said. The government in Kathmandu is also introducing Chinese language classes for high school students, so future graduates can better communicate with their northern neighbours. Nepal bares China-tempered steel. India better get used to it By comparison, India’s efforts at boosting bilateral ties seem fairly lacklustre. Dr Nishchal Pandey, head of the Nepal-based Centre for South Asian Studies think tank, said many South Asian countries had high hopes for the Indian prime minister at the beginning of his tenure. But these soon fizzled out. “His ‘neighbourhood first’ policy, hands-on approach to the several bilateral and regional mechanisms, and allocation of more budget for border infrastructure projects generated optimism [initially],” Pandey said. India’s election set to test limits of Modi’s populism Even the eight-member advisory committee formed in 2016 to outline long-term policies for revamping bilateral relations, known as the “Eminent Person’s Group on Nepal-India relations”, seems to have stalled in its mission. The group has yet to deliver its report to Modi, despite finishing work on it by the middle of last year. This report will only be made public once it has been submitted to the leaders of both countries – but with Modi set to face the electorate in a few months and his party entering campaign mode, it is unclear how high foreign policy is on the Indian prime minister’s agenda.