This paper is focused to examine the empirical relationship between fiscal deficit, money supply, and inflation to test the hypothesis that domestic factors fiscal deficit and money supply and external factor Indian inflation have positive effect on the inflation in Nepal. Nepal has open border with India and India is the major international trade partner of Nepal. Therefore, economy of Nepal can be influenced by the macroeconomic variables and policies of India. The study has analyzed the time series data from 1990 to 2011. Econometric techniques used in the study are unit root test, autoregressive distributed lag (ARDL) model and Granger causality test. The empirical results show that there is positive effect of fiscal deficit and narrow money supply on consumer price index of Nepal in short run and long run. But, the relationship is weak and the effect is very small. While adding wholesale price index of India as an explanatory variable along with fiscal deficit and narrow money supply, it shows the significant short run and long run relationship among the variables. The positive and significant effect of Indian wholesale price index is higher than the effect of fiscal deficit whereas narrow money supply has not significant impact on consumer price index of Nepal. Therefore, inflation in Nepal is affected by external factor rather than domestic factors. Consequently, inflation controlling through monetary policy and fiscal policy are becoming ineffective in Nepal. Thus, Nepal should diversify the over dependent trade with India and explore the markets in other countries as well.