Deepening Trade Dependency of Nepal

There is growth and development of international trade because of globalization, liberalization, open market and increasing use of technology. Nepal is not exception from the changing world but unable to grab the opportunities created by changing market scenario and still dependent on foreign trade in terms of import. Nepal government is still enjoying the increasing revenue primarily based on custom duties from import.In my viewpoint, there are two layers of dependency, which pushes the Nepalese economy backwards.

At First, Nepal is dependent on trade because production within the country can’t fulfill the demand of goods within the country. Secondarily, there is unavoidable trade dependency with India. Trade with India become compulsion because Nepal as landlocked country share open border of 1876 square kilometers with India. There is Chickens neck "a narrow strip Passage in India : Siliguri Corridor" for direct trade link with Bangladesh and elephant like giant mountains with difficult physical structure to trade with China.

                                                                                           Source : author's computation using data from CBS Nepal(2016)

Over the years, export has almost been stagnated, and the import skyrocketed.The slow growth in export compared to the robust growth in import remains a major concern for Nepal. The average growth in export was 4.2 percent in the last decade whereas growth in import during the same period was 18.2 percent. Nepal’s import is 9 times bigger than export.                     The total export, which used to be 14.58 percent of the Gross Domestic Product (GDP) a decade ago in F/Y 2004/05, has squeezed to 11.67 percent, whereas import has swelled to almost 41.66 percent of GDP in F/Y 2014/15 - in F/Y 2004/05 it was 29.48 percent. During the last decade, import increased by 5.08 folds to Rs. 885 billion whereas export increased by 2.88 folds to Rs 239 billion in F/Y  2014/15. As a result, trade deficit was swelled by 7.35 times in the last one decade and has reached to Rs. 645 billion.The growing and continued mismatch between import and export has resulted in an alarming level of trade deficit in Nepal.

India continued to command a major share in Nepal's foreign trade. With Indian economy's growth accelerating and manufacturing as well as industrial base enhanced further and strengthened, India’s share in Nepal’s total merchandise trade in the last fiscal year increased to 64 percent - in 2003-04, it was 58 percent. China's trading share with Nepal also doubled in the last 5 years to 12 percent and around one fifth of the trade with India. The share of other countries continued to decline to 26 percent of Nepal’s total trade last year, with Nepal shifting its long-running dependency on other countries for the imports of vehicles and machinery, equipment, among others, to India.There are some reasons behind the increase in deepening trade dependency of Nepal.

Consumption Oriented Economy

Economic growth and fixed capital formation is a sluggish but demand in Nepal has remained strong in the last one decade because of remittance earning by migrant workers. If we compare the domestic savings-to- GDP ratio, which is currently around 10.10 percent, and national savings-to- GDP ratio standing at 40.27 per cent, the difference is larger due to remittance. Against the national savings-to-GDP ratio at 40.27 percent, the total fixed capital formation-to-GDP ratio is 22.58 percent, which reflects the failure of Nepali society to make productive use of remittance driven national savings.

Ratio of remittance as percentage of GDP was just 0.46 percent in 1990/91 AD and has significantly increased after the year 2000/01 and Nepal received remittance 29.11 % of GDP worth in fiscal year 2014/15. The ratio of remittance to GDP has highly increased in the nation because the increasing rate of remittance inflow is more than the increasing rate of GDP.

Increasing flow of sweat dollars have induced high consumption, which has in turn fueled higher importing driving the country’s trade deficit even further. But the government is enjoying the revenue generated by the higher imports, generating a kind of complacency, which is also called “Dutch Disease”.

For every rupee of remittance, the government raises 12 paisa through consumption tax (not counting its direct tax contribution). By taking a free ride on remittance and not correcting its negative effects, both fiscal and monetary policies have exacerbated the human exodus and the hollowing-out process. In a country where basic needs are unfulfilled, it is unusual that most remittance (80 percent) is consumed. The problem is not consumption; it is the lack of domestic production and exports to finance consumption. The problem is not low savings either; it is the lack of opportunity to invest and the policy-induced diversion of investment into sectors that do not increase employment and GDP but promote rent extraction.

Remittance revenue is increasing but domestic industries are not capable to seize the opportunities in meeting increased demand of basic goods such as construction materials, household goods and clothing. Then, Nepal had no options but importing such items from other country. Hence trade dependency /import increased by 3.3 time in the last one decade with average annual growth of 15 percent.

Industrial Base is Very Low:

Apart from its contribution to economic growth, production, distribution creation of employment opportunities to the people, the private sector has an important role to play in the service delivery to the people through the market mechanism. Nepal’s manufacturing sector has not seen a robust growth. Even the growth in service sector remains in conventional sectors, not in the modern sectors.  Shrinking industrial activities is one of the disturbing features of Nepal's economy. The industrial sector that used to contribute 18 percent to the GDP a decade ago has squeezed - 15 percent in last year. The contribution of industry group to GDP stood 14.1 percent in 2010-2011 whereas the contribution of manufacturing to GDP was 6.5 % - annual average growth rate of 2.5% in the manufacturing sector in the last decade. 

         Source :author's computation using data from CBS Nepal(2016)

A decreased from 10 percent to 6.5 % of the manufacturing sector's contribution to GDP indicates that industrialization in Nepal is very much sluggish. This also indicates that Nepal's industries failed to capitalize the opportunities unveiled by the remittance-fueled consumption in the domestic economy, compelling the domestic economy to depend on imports to meet increased internal demand, let alone producing goods for exports. Industrial base become very poor because of poor investment, lack of raw materials, worst condition of energy, Increasing production cost, frequent strikes , blockade and government change.

Poor state of Infrastructure and policy support

The biggest constraint that is limiting the prospects of industrialization in Nepal is current status of infrastructure, which is very poor.

Nepal consistently stands out as a country with one of the poorest logistical and enabling trade infrastructure in the world. Nepal ranked 105 out of 160 countries with LPI score 2.59 in Logistical Performance Index (LPI) in 2014(World Bank).Lack of access to sea that adds around 15% to transit related transit cost in export compared to the countries that have access to sea. There are other major problems to develop strong industrial base are:

• Shortage of electricity:The shortage of electricity is forcing firms to operate at far less than the captive capacity. According to Enterprise Survey 2013, the percentage of firms owing or sharing generator jumped to 50.5% in 2013 from 15.8% in 2009 and almost 69 % firms identified electricity as a major constraints in 2013.
• Inadequate Transportation: Inadequacy of existing transport infrastructure and logistical hassles has been increased product costs and export competitiveness. About 1/3 rd of manufacturing firms identified bad transport facilities as a major constraints in 2013.
• Lack of adequate facilities for warehouse, handling equipment’s, scanning machines and testing laboratories have limited the prospects of export promotion.
• Poor financial access: There is very few practice of consortium financing by banks for huge projects and they rarely invest for small entrepreneurship development, because they are unable to put sufficient collateral to access  financial source for new venture investment.
• Underdeveloped Capital market: Nepal’s capital market is relatively under developed. This has resulted in low capital formation and in turn low investment.

Policy inconsistencies and implementation paralyses is another major problems in Nepal’s increasing trade dependency. After two decades of delay, the establishment and ope rationalization of Special Economic Zone (SEZ) in Bhairahawa. Similarly the “one window” facility for exporters and provision like “No Work No Pay” remains unimplemented. There is possibility that existing set of policies and sect oral promotion strategies may be termed ineffective without first fully implementing them and taking adequate time to evaluate actual output.

Poor Business Doing Environment

The World Bank’s annual Doing Business Report shows Nepal’s ranking at relatively low level. Nepal has the highest export lead time (days) in the region, as it needs 11 documents, 42 days and costs US$2,295 to export a container. According to doing business report 2016, for easing doing business ranking Nepal stands at 99 position out of 189 countries having DTF (Distance to Frontier) score 60.41.

Nepal’s long running political instability in the name of democracy has produced many negative effects to the economy.Industrial unrest's and strikes that are often organized by sister organizations of leading political parties. As a result, industrialists are often forced to talk to outsiders such as political leaders to settle unrest's and strikes in their factories.

Unpredictable strikes and unrest's have made exporters struggling all the time to meet supply deadlines set by foreign buyers. Such activities also further add to cost of production and erode competitiveness. Similarly, rigid labor policy that bars enterprises to adjust labor force as per the change in demand in the market. As per existing law, employees get permanent status after working for more than 240 days and after getting a permanent status, they can’t be fired until they are proven engaged in criminal activities. The provision has become a recipe of disaster for order-based industries such as ready made garments and woolen rugs and season-based industry such as tourism and hotels. Enterprises are compelled to keep on paying to the laborers even during the lean seasons, something that swells cost of doing business. Garments and Pashmina Productions are hit by the shortage of workers of all skills range. There is shortage of labor due to large scale migration.

 Dependency With India

Since transit through china is virtually impractical. India is viable for all commercial flows.  Nepal and India are two neighbors having unique relations dating back to antiquities perhaps even before the dawn of human civilization. Nepal share an open border of 1876 square kilometers with India and Nepalese currency is pegged with Indian currency. India is Nepal’s largest trade partner and source of foreign investment. Nepal's economic development has been inextricably linked with India. 

Source :author's computation using data from NRB(2016)

India is the largest single partner in Nepal's foreign trade and Nepal's dependence upon India for essential commodities has been immense India is also the only transit providing country for Nepal.Nepal;s transit trade is routed through twenty two designated routes from India-Nepal border to the port of Kolkata/Haldia. In addition, Nepal's trade with and through Bangladesh also transits through India. Increasing trade dependency on India because lack of development of productivity and competency compared to Indian products.

Nepal's dependence on India took an upward trend after the southern neighbor adopted an open market policy. The central bank's report shows that Import from India in F/Y 1989/90 is 4674.5 million rupees and it becomes 491655.9 million rupees in 25 years period of  time at F/Y 2014/15 with average growth of 20 percent. Trade deficit with India 4072 million rupees in F/Y 1989/90 and deficit mounting 435791.3 million rupees in 25 years. But export to India in F/Y 2014/15 it becomes 55864.6 million rupees. Which reflects very poor growth in exports and increasing trade deficit with India.                                                                        Source :author's computation using data from NRB(2016)

This figure reflects that there is huge trade deficit with India  than other third countries. Which is not a new phenomenon and it has been increasing in line with our excessive dependence on the Indian economy. High trade deficit and an unfavorable balance of payments situation signals troubles in an economy—especially its capacity to ensure exchange rate and macroeconomic stability, and to sustain imports levels to support rising domestic demand for foreign goods and services. There is consensus among policymakers and analysts that the rising trade deficit is unsustainable. It needs to be re-balanced. The only way we can correct trade balance with India is to increase exports. India has already opened up its market for most of the goods exported by Nepal. Unfortunately, Nepal has failed to advantage of the opportunities.

After signing the transit agreement with china, it is widely anticipated that Nepal will do business through Chinese ports and its dependency on India will reduced. Such interpretations, particularly in Indian circles, are beyond the ground realities and one should understand that a transit treaty does not necessarily  measure up to implementations.