It really depends on the motive of the person asking. Some people are just curious. I mean they don't know the difference between Nepal and Timbuktu. But on the other hand, I don't think that us Nepalis should be ashamed of our country in answering that question. There is nothing wrong with being from Nepal.

There was one time when I saw a family at the mall and I am quite sure that they were Nepali. So I approached them and not wanting to be pre-sumptuous I asked them, "Excuse me, where are you from?"
The older male in the family says, "India."
I was so convinced that he had to be Nepali so I asked, "Nepal or India..?"
The guy looked a little surprized that I asked him that and he said, "..oh..tapai Nepali ho? I am from Nepal also."

I thought it was a little sad. Maybe people have never heard of Nepal. But if every Nepali in America feels that it is too troublesome or embarrasing to explain that they are Nepali and where Nepal is, then no one will ever hear of Nepal. Why say that you are from India, just because more people have heard of India than of Nepal?