Rajan Silwal ECD

7/27/2019 Rajan Silwal ECD

1/109

Graduate School of Development Studies

The Causes of Trade Decit of Nepal

A Research Paperpresented by:

RajanSilwal

(Nepal)

in partial fullment of the requirements forobtaining the degree of

MAS!RS "# ARS $N %!&!'"PM!NS%$!S

Specialiation:

Economics ofDevelopment

(ECD

)

Members of the e*amining

committee: %r 'oreno

Pellegrini

%r +o,ardNicholas


2/109

he +ague- heNetherlandsNo.ember-

/001


3/109

2

Disclaimer:

his document represents part of the author2s studyprogramme ,hile at the $nstitute of Social Studies3 he

.ie,s stated therein are those of the author and notnecessarily those of the $nstitute3

Research papers are not made a.ailable for circulation outside ofthe $nstitute3

n!uiries:

Postal address: $nstitute of Social StudiesP3"3 4o*

/5667/80/ ' he

+aguehe

Netherlands

'ocation: 9ortenaerade ;//8;1 A< he

+aguehe

Netherlands

elephone: =>; 60 ?/7 0?70

#a*: =>; 60 ?/7 0655


4/109

"c#nowled$ements

#irst and foremost- $ ,ould lie to e*tend my cordial thansto my super.isor %r 'oreno Pellegrini for his indguidance3 +e has been a continuous source of inspirationand encouragement and under his ad.ice@ this ourney ofmy research has been incredibly e*citing and smooth3

he BseedB of this research paper ,as an outcome of thediscussion ,ith my second reader- %r +o,ard Nicholas3+e has al,ays boosted my morale by pro.iding me ,ithdetailed comments and suggestions to ensure that $ learnthe basics of research3 $ am glad to be able to e*tend myspecial thans to him3

$ am indebted to the Co.ernment of Nepal for nominatingme to pursue this degree and to the Netherlands#ello,ship Programme for pro.iding me ,ith this,onderful opportunity3

"ther important names that $ ,ish to acno,ledge fortheir inspiration and assistance along the ,ay are 'iDMieEu- Almas Mahmud- Shi.a Ra 4hatt-Aaya 9rishnaShrestha- Fonchesta 9abete- Sintayehu +ailu Alemu-$fteharAhmed Robin- Mahahliso Noana and Goy Misa3Similarly- $ ,ould lie to e*tend my sincere thans to all

staff members of !F% programme in $SS3

'ast but not least- $ e*press my gratitude to my parents- my,ife Nita- my sons Abhina. and Anurag- and my nephe,Sharad for their continuous support and for the sacricesthey ha.e made during my stay and study abroad3

$ am fully responsible for all the errors and omissions- ifany- in this research paper3

RaanSil,al

he+ague;/th No.ember-/001


5/109

Ta%le of Contents

Acno,ledgements >

'ist of ables 7

'ist of #igures 7

'ist ofAcronyms 1

Abstract ;

Rele.ance to %e.elopment Studies ;

9ey,ords ;

Chapter & ntroduction &

;3; he 4acground ;

;3/ Policy Rele.ance andGustification ;

;3> Research "becti.es and Huestions ;

;3? Research +ypothesis ;

;38 %ata and Methodology ;

;37 Scope and 'imitations ;

;36 "rganiation of the Study ;

Chapter ' Review of (iterature and Theoretical &

/3; 'iterature Re.ie, ;/3/ Re.ie, of !mpirical Studies on Fauses of rade ;

/3> Nepalese Studies ;

/3? heories on Fauses of rade %ecit ;

/3?3; !*ternal Shocs and rade %eficit ;

/3?3/ #iscal %eficit and rade %eficit /

/3?3> Monetary Policy and rade %ecit /

/3?3? rade 'iberalisation and rade %ecit /

/3?38 !conomic Cro,th and rade %ecit /

/3?37 'ac of Fompetiti.eness and rade %eficit /

/3?36 'andlocedness and rade %ecit /

/3?31 Political $nstability- Fonflict and rade /

Chapter + Structure and Direction of )orei$n '

>3; rade Structure/8


6/109

>3;3; ".erseas rade Fomposition of Nepal /6

>3;3/ Number of Products !*ported and /1

>3/ %irection of #oreign rade of Nepal /1

>3/3; Mo.ement of rade ,ith $ndia and "ther >;

>3/3/ %irection of %ecit Fompared to rading >/>3/3> rade %ecit in Coods: $ndia and "ther >/

>3/3? Cro,th Rate of !*ports and $mports >>

>3/38 Furrent Account 4alance >?

>3/37 NepalBs rade Policy >8

Chapter , "nal-sis of Causes of Trade Decit of Nepal

?3; !*ternal shocs and rade %ecit >7

?3/ 4udget %ecit and rade %eficit ?0

?3> !*cess Money Supply and rade %eficit ?;

?3? Real !*change Rate and rade %eficit ?/

?38 rade 'iberalisation and rade %ecit ??

?37 !conomic Cro,th and rade %ecit ?7

?36 'ac of Fompetiti.eness and rade %ecit ?1

?31 'andloced Ceography and rade %ecit 80

?35 FonIict and rade %eficit 8;

Chapter * Conclusion and /olic- Recommendations

83; Fonclusion 8>

83/ Recommendations 88

References 87

Notes 7/

Appendices 7?


7/109

(ist of Ta%les

able >3; !*ports of Some Maor Fommodities to $ndia($n Million Rupees)

/8able >3/ !*ports of Maor Fommodities to "ther Fountries

($n Million Rupees) /

able >3> Fomposition of ".erseas rade of Nepal (J) /

able >3? Periodic rade 4alance (;567D08) >

able >38 rade 4alance (Coods and Ser.ices) in%iKerent Fountries

>

able ?3; rade 4alance 4efore and After 'iberalisation ?

able ?3/ rade 4alance in Neighbouring Fountries:4efore andAfter ?

able ?3> Annual Percentage Fhange of 'abour Fosts and 'abourProducti.ity of !ight Asian Fountries?1

able ?3? $nde* of Fost Fompetiti.eness $ndicators of NineAsianFountries- ;555 ?

able ?38 Fomparati.e Fost of !lectricity and Eater ?

able ?37 'ogistic Performance $nde*: NeighbouringFountries and

8

able ?31 rade 4alance in Coods and Ser.ices (J of C%P) in

FonIictPeriod8/

(ist of )i$ures

#igure ;3; rade 4alance of Nepal since ;578 (in Coods ;

#igure >3; Number of Products: !*ports and $mports /

#igure >3> rade 4alance in Coods and Ser.ices /

#igure >3? rade 4alance in Coods and Ser.ices >

#igure >38 rade 4alance in Coods- Ser.ices and $ncome >

#igure >37 rade 4alance ,ith $ndia and "ther Fountries >

#igure >36 !*port and $mport (Coods only) Nepal >


8/109

#igure >31 Furrent Account 4alance >

#igure ?3; !*ternal %emand Shocs (9ey Fommodities) >


9/109

#igure ?3/ !*ternal %emand Shocs: $ndia and ".erseas Fountries(All Fommodities)>6

#igure ?3> "il Price Shocs- $nflation and %irection of NepalBs#oreign

rade>1

#igure ?3? $nternational Price of Petroleum and rade Performance ofNepal >

#igure ?38 he ,in (4udget and rade) %eficits ?

#igure ?37 Sa.ingD$n.estment Cap and rade 4alance ?

#igure ?36 !*cess Money Supply and rade 4alance ?

#igure ?31 Mo.ement of R!R and rade 4alance ,ith ?

#igure ?35 Mo.ement of R!R and rade 4alance ,ith ?

#igure ?3;0 !conomic Cro,th and rade 4alance ?

#igure ?3;; !conomic Cro,th in Maor rading Partners ?


10/109

(ist of "cron-ms

AAN Action Aid Nepal

A%4 Asian %e.elopment 4an

AR$F Asia Regional $ntegration Fenter

4% 4udget %ecit

4oP 4alance of Payments

F# Fapital and

#inancialAccount ch3

Fhapter

FA FurrentAccount

F4S Fentral 4ureau of Statistics

FP$ Fonsumer Price $nde*

!C !conomic Cro,th

!R !*change Rate

! !uropean nion

#%$ #oreign %irect $n.estment

# #iscalear

CF$ Clobal Fompetiti.eness $nde*

C%P Cross %omestic

Product C%S Cross

%omestic Sa.ing CNP

Cross National Product C L S

Coods and Ser.icesCoN Co.ernment of Nepal

$#EC $ntegrated #rame,or Eoring Croup

$'" $nternational 'abour "rganiation

$M# $nternational Monetary #und

$Re $ndian Rupee

''%Fs 'andDloced %e.eloping Fountries

'P$ 'ogistics Performance $nde*

M $mport

M; Narro, Money

M/ 4road Money

M#A Multi #ibreAgreement

Mo# Ministry of #inance

MS

Money Supply n3a3


11/109

not a.ailable n3d3

no date

N!SP!F Nepal Social %e.elopment and PeopleBs!mpo,erment

Fentr

e


12/109

NR4 NepalRashtra 4an

NRe Nepalese Rupee

"'S "rdinary 'east Squares

P$ Political $nstability

R!!R Real !ffecti.e !*change RateR!R Real

!*change Rate RMC

ReadyDmade Carment Rs

Rupees

SAARF South Asian Association of RegionalFooperation

SAE!! South Asia Eatch on rade- !conomics and!n.ironme

nt

SD$ Sa.ingD$n.estment4 rade 4alance

% rade %ecit

!PF rade and !*port Promotion Fentre

#P otal #actor Producti.ity

N nited Nations

NFA% nited Nations Fonference on rade and%e.elopme

nt

N$%" nited Nations $ndustrial %e.elopment"rganiation

S nited States

E4 Eorld 4an

E%$ Eorld %e.elopment $ndicators

EC$ Eorld

Co.ernance $nde* E"

Eorld rade "rganiation )3 heir ustication isthat it can create unemployment or high e*ternal debt ornancial and political problems (not all good)3 $t also helpsll lo, domestic sa.ing and social ,elfare due to higherconsumption (not all bad)@and not irrele.ant in the sensethat it has association ,ithmacroeconomic .ariables3

$n a research for $nternational Monetary #und($M#)- Chosh and

Ramarishnan (/007) percei.e the FA decit from threeperspecti.es- as the


24/109

diKerence bet,een the .alue of e*ports and imports of goodsand ser.ices@ gap in national in.estment and sa.ing@ andinterDtemporal trade3 $f the deficit is due to high Qe*ternalin.estment- according to the authors- it does reIect only alo, le.el of sa.ings and no need to ,orry pro.ided

in.estments are channelled to output gro,th3 Similarly-there is no harm of importing more goods- the authorscontend- thereby incurring a % today and e*porting thesame tomorro, enoying a surplus3 $n addition- if the decitis easily nanced by foreign capital as done by Australia andNe, ealand- it is not bad but it canbe bad if there is problem of nancing the decit due to ,ithdra,alof pri.atefinancing as in Me*ico in ;558 and hailand in ;556 (ibid)3

d,adia and Agmon (;511) .ie, the % from economic-political and moral standpoint and argue that it is a TnoproblemT situation3 he authors argue that any potential

crises due to a persistent % are o.erstated by political andmoralistic perspecti.es and it has little implication ,ith theeconomic impacts3 #rom a political corner- the argument isthat a trade surplus is contended as Bgood for the countryBand a must for those ,ho thin that po,er comes fromprot3 "n moral ground the decit is BbadB ,hen people say-Bdo notconsume more than your meansB and Bsa.e for a rainydayB (ibid)3 +o,e.er- the authors ha.e acno,ledged theinterplay of these three perspecti.es to turn the % as aproblem3

he Sunday imes (/6 Guly /001) oKers a critical ,riteD

up about % and clusters the ideas from optimistic andpessimistic sides3 %epending upon the nature of importsand its utiliation- a % can be assessed ,hether or not ithelps gro, the economy3 $t is good if the imports are madeto boost the production of tradable goods andUor in.estmentgoods3 $t is not bad if it does not create a problem of4alance of Payments (4oP) or run out the foreign e*changereser.es of the country or it is only caused by shortDtermcyclical shocs3 he Paper ,rites- if the deficit is due to thebuilding of infrastructure of the nation or the industrialbase- or the imports of ra, materials or due to high inflo,of foreign aid and foreign direct in.estment (#%$) into

producti.esector@ no need to ,orry since they ,ill reco.er the deficit inthe nearest future3 +ence the question is not the % per sebut the underlying rationale behind it3 he paper rightlyemphasies that irrespecti.e of the 4oP surplus- a % isliely to raise a problem of higher e*ternal liabilities in thefuture ,hich ,ill further deteriorate the importing capacity


25/109

of the economy and distort the much needed resourcesto,ards the debt repayment and ser.icing3

Moon (/00;- /008) presents e*tensi.ely in his papersabout ho, a % hampers the economic gro,th of countriesand leads to accumulation of higher foreign liabilities-dependence- distortion of national priorities- slo,ergro,th and de.elopment- and potential nancial crises asin 'atinAmerican and !ast Asian countries in the past3Moon (/007: //) has carefully criticiedthe neoliberal claims that Bthe NorthDSouth di.ide could benarro,ed- if only the poor countries ,ould emulate theeconomic policies of the richB3 heauthor argues that B it is not their e*pansion of trade

.olumes that should be copied but their prudent a.oidanceof trade deficits in the past and presentB Qemphasis added(ibid)3 #rom the abo.e discussion- it is clear that (i) tradedeficit is e*istent in many countries@ (ii) economists ha.e

different perceptions to consider it as a problem@ and (iii)regarding the sources of problem3


26/109

'1' Review of Empirical Studies on Causes of TradeDefcit

Saruni (/006) has unco.ered three main factors responsiblefor ananiaBs persistent %3 he author has used

go.ernment e*penditure- household consumption- reale*change rate (R!R)- #%$- income from the rest of the ,orldand trade liberalisation in his logDlog ordinaryDleastDsquare("'S) regression model for the data during ;560D/00/3 hepaper nds that the go.ernment e*penditure- #%$ andincome from abroad played a positi.e role inthedetermination of trade balance (4) despite the negligiblecoeKicient of the #%$3 "n the other hand- householdconsumption- R!R and trade liberalisation deteriorated the43 Some of the findings in SaruniBs paper are in line ,iththeories and some are not but his "'S approach for timeseries analysis suKers some methodological limitations3

he NFA% (;555: 58D6) presents an econometricanalysis of 4 using the panel data of ;7 countries o.er /7

years3 +ere- 4 to C%P ratio is dependent .ariable ,hereasgro,th- purchasing po,er of e*ports- gro,th rate inindustrial countries and economic liberalisation aree*planatory .ariables3 $tis found that the acceleration of gro,th rates in de.elopingcountries increased the % ,hile liberalisation ,orsened itsignificantly3 'ie,ise- better terms of trade and rapideconomic gro,th in industrial countries helped lessen the% inde.eloping countries3

A ,ider concept of 4 is represented by the FA and thedeterminants of ,hich are often .ery same as thedeterminants of %3 Purohit (/006: 8?) foundthat thedeterminants of $ndiaBs FA decit are not the ,idelybelie.ed changes in stoc of money or scal balance3 heauthor highlights the lac of competiti.eness (in themanufacturing sector)- supplyDside constraints of domesticeconomy and inflation through international price shocs(in oil and food) as some maor determinants of %- and FAdecit in turn3 he analysis is based on time series datafrom ;560D/008 in the regression analysis and the

.ariables are FA to C%P ratio- e*cess money supply (MS)-

gross scal deposit- real eKecti.e e*change rate (R!!R)-and FapitalD"utput ratio3 +o,e.er- the author has largelypursued e*ploratory data analysis3

"nafo,ora (/007) e*amined the causal relationshipbet,een budget

deficit (4%) and % in case of Nigeria using a regressionmodel ,ith the data from ;560D/00;3 he study .ariables


27/109

are %- 4%- MS- domestic income- discount rate- and R!R3he author has found a positi.e longDrun relationshipbet,een 4% and %3 4ut contrary to the con.entionaltheory- the paper highlights that the causality runs from %to 4% since Nigeria is highly dependent on the e*port ofpetroleum products3 $n addition- the paper has obser.ed apositi.e correlation of % ,ith MS and depreciation ofdomestic currency3 Mean,hile- increased domestic incomeand rising interest rates had ,orsened the % (in Nigeria)in the longDrun3 $t is due to the fact that the former raisesthe demand for foreign goods and ser.ices ,hile the laterencourages capital inflo, that necessitates appreciation ofhome currency@ and again more imports from abroad3

Anoruo and Ramchander (;551) in.estigatedrelationship bet,een Bt,in deficitsB in .e de.elopingcountries using time series data (;586D5>)3 he authorsha.e included both the de.eloped (for e*ample- the S)

and


28/109

de.eloping countries in their study3 he analysis is basedon.ector autoregressi.e model and the direction ofcausality bet,een the t,o decits has been tested by theCranger causality test3 he study re.ealed that the %causes 4% and not the .ice .ersa3 hat is- a ,orsening of

% forces the go.ernment to spend more to help minimiethe domestic hardships3 +o,e.er- in case of Malaysia- theauthors noticed a ,ea bidirectionalrelationship too3 $n the model- shortDterm go.ernmentinterest rates- the tradeD ,eighted !R of the local currency-C%P- and inIation rate ha.e ser.ed as e*planatory

.ariables3 Fontrary to the documented cases in the S andother de.eloped countries- the authors ha.e found aunidirectional causality from current (trade) accounts to 4%3#urthermore- the causality bet,een increase in C%P and %,as significant only in the case of $ndia and Malaysia3

FalderVn et al3 (/000) in their research for the Eorld

4an found thatBcurrent account deficits in de.eloping countries aremoderately persistentB@ an increase in domestic output gi.esrise to a higher FA decit@ terms of trade loss orappreciation of R!R@ and an increase in internationalinterest rates or higher gro,th rate in industrial economieslessen the FA decit in de.eloping countries3 he research isbased on crossDcountry panel data of ?? de.elopingcountries co.ering the period from ;577D583 he .ariablesunder study for pooled timeDseries are pri.ate and publicsa.ing rates- international real interest rate- the e*tent of4oP control- R!R- the share of e*ports in gross nationaldisposable income- national income (domestic andinternational)- and theterms of trade3

'1+ Nepalese Studies

o the best of my no,ledge no pre.ious study has beendone ,hich ,as in.estigating the causes of % of Nepal3+o,e.er- there are some ,riters and organiations ,hoha.e e*pressed their concern on ,ea e*port performanceand %3 $n almost all cases- the authors ha.e raised their

arguments on the problems lie inadequate di.ersication(A%48- /00?@ SAE!!7 /007)- lac of competiti.eness(4hatt /008- $#EC6 /00>: 5- Mo#1- /00?U08- Poudyal/006- Shaaha /001- Sharma /00?)- o.er.alued !R due tothe *ation of Nepalese Rupee (NRe) ,ith $ndian Rupee(Panta /006)- and ,orsening terms oftrade (Singh /001)-e*ternal shocs (9oirala et al3 /008)3 Similarly- structural


29/109

bottlenecs and landlocedness (%e.ota n3d3- Shaaha/001)- absence of in.estmentDfriendly policy en.ironment(Mo# /00?U08) Qpace of trade liberalisation (4hatt andSharma /007 )- changes in international demand or theBdemand shocsB (Shaah /001)- insurgency and stries inthe country (9oirala et al3 /008)- and to some e*tentbilateral trade treaty ,ith $ndia (9oirala et al3/008- Mo# /00>U0?) are also considered responsible for the %3Most of thesearguments are made in institutional publications-ne,spapers- and public forums3 Some of them arebriefly discussed here3

he A%4 (/001) and $#EC (/00>) see the reducedcompetiti.eness in readymade garments (RMC)- pashminaand ,oollen carpets as responsible for declining e*ports too.erseas5 countries thus leading to %3 "n the other hand-in its report- SAE!! (/007: 6D5) emphasies that NepalBs

e*port di.ersification policy is hardly eKecti.e and the trade,ith $ndia constitutes a


30/109

big share of decit3 he report claims that the gro,th inimports has out,eighed the e*port gro,th ,hich haspropelled the deficit further3 Prasad (/006: //) sees boththe role of ,ea e*port capacity and imports of lu*urygoods in the % of Nepal among others3 he author claims

that the composition of e*port baset of Nepal is notdi.ersified compared to its ,idely .aried imports3

According to Sharma (/00?)- B$ndiaBs abnormal protmoti.e reIected in trade negotiations and tariK and nonDtariK barriers imposed infrequently upon Nepal is alsocausing hea.y trade deficit and hence- damage to theNepalese economy3B Similar arguments are put by 9oirala etal3 (/008)- Prasad (/006) andA%4 (/00?) that underline therestricti.e NepalD$ndia rade reaty for damaging e*ports ofNepal after /00/ ,hich is responsible for a t,oDdigit %3

here are opposing .ie,s about the !R regime and the % ofNepal3 "ne

.ie, emphasies that the *ed !R ,ith the $ndian currencyis detrimental to the Nepalese trade ,hereas another .ie,percei.es it benecial in general (he 9athmandu Post- /

Gune /00>)3 %e.ota (n3d3)- using a regression equation-in.estigated the causality bet,een R!R and 4 of thecountry3 he author found that !R de.aluation is not helpfulto achie.e impro.ement in %@ and de.aluation alone hardlyhelps minimie the % if it is not supported by othereconomic tools3

Regarding the causal relationship bet,een budgetdeficit and FA decit-Acharya (;555: 87D5) found that

Nepalese B333budget decit is significantly e*plaining thecurrent account deficitB3 And- the author sees consistency inthe neoDclassical doctrine a higher le.el of fiscal decitleads to higher le.el of FA decit3 Regarding the impact oftrade liberalisation in Nepal- Acharya and Fohen (/001)ha.e demonstrated that both the budget and trade decitsdo ,iden under the oneDtime liberalisation of !R and tradedue to the appreciation of domestic currency3 he authorsha.e estimated the % 038>J and ;3?>J more than thebaseline .alue under trade liberalisation- and trade and !Rliberalisation respecti.ely3

'1, Theories on Causes of Trade Defcit

#rom the re.ie, of literatures it is ob.ious that there are anumber of causes of % in different countries3 Among them-fiscal and monetary policies- e*ternal shocs (particularly-demand and price)- trade liberalisation- economic gro,th-lac of competiti.eness and landlocedness are maor ones3


31/109

$n this subDsection- efforts ha.e been made to outline thetheoretical frame,or on the basis of these determinants3 $thas also been considered as the analytical frame,or forthis research3 hey are discussed one by one3

'1,1& Eternal Shoc#s and Trade Decit$n an open economy- either the demand shocs or the priceshocs transmitted from global economy can produceunfa.ourable circumstances in a countryBs 4andmacroeconomic stability3 he Asia Regional $ntegrationFenter (AR$F n3d3) states ho, a slo,do,n of gro,th inmaor economies- particularly the S and the frequent hiesin the oil prices are transmitted across countries .ia


32/109

trade- in.estment- nancial Io,s and mo.ement of ,orersand their remittances3 Some other e*ternal shocs canemerge from global interest rate and shifts in scal andmonetary policies of big economies (Gansen /001)3 hetransmission of shocs is obser.ed in the asset prices-

domestic interest rates- appreciationUdepreciation of !R-imbalances in trade and current account and real economicacti.ities3 Ne.ertheless- the impact of shocs depends on acountryBs degree of trade openness- capital inIo,s- and sieof the economy3

4esides- the AR$F (n3d3) states that a supplyDside shocthat has risen from a sharp rise in imported input (fore*ample- energy)- for ,hich demand and supply arerelati.ely inelastic is more liely to raise the output price-slo,er gro,th but higher inIation3 he rise in output prices,ill end up in a loss of competiti.eness thereby causingsmaller e*ports and %1 he price shocs directly hits the

terms of trade- for e*ample- Sch,art (;515: ch3 ?) statesthatin the 3S3 the terms of trade and the % mo.ed togetherafter the Eorld Ear $$ ,here changes in the domesticdemand for imports and residual supply of e*ports ,ere t,odri.ing forces behind the %3 Fon.ersely- the demand sideshocs appear from the sudden and sharp decrease in thedemand for imports by maor economies3 he demandshocs- according to Solanes et al3 (/006)- transmit theireffects through t,o channels the R!R and domesticproduct and these eKects are stronger3 %esamanya (/007)

contends that e*cept internal imbalances- a sudden increasein oil price ,ill ,orsen the %- create disturbances ino.erall 4oP- losses in countryBs foreign e*change reser.esand pressure on the !R3 Similar arguments are gi.en by

&atanse.er and 9utlay (/001)- Manrique (/00?) and A%4(/008) in the conte*t of other countries3

'1,1' )iscal Defcit and Trade Decit

As mentioned in the earlier section- there are t,o lines ofthining and conclusions that the causality runs from 4% to% or .ice .ersa3 Ehether ,e see at broader perspecti.e of

FA deficit or a component of that the %- the causality isnot the same3 $n macroeconomic accounting- nationalsa.ings are disaggregated into pri.ate and public sa.ings3

And- ob.iously- scalUbudget deficit indicates go.ernmentdissa.ing3 he relation bet,een them can be sho,n asbelo, (Mueller /007):

i)


33/109

ii) N< W S $

Ehere


34/109

i.) 4oP W N< = F#

W 0.) N< W F#

Ehere- F# is total of capital and nancial account ,hichcompensates the

current account andUor trade decit3 +ere too- t,o inds of

arguments are found3 #or some- a negati.e FA is nancedby a positi.e F#- hence the inflo, of capital is the TcauseTfor the negati.e 43 #or others- % is due to lo, public andpri.ate sa.ing and public debt3 Fiting ruman- Purohit(/006: ;6) contends that FA decit and fiscal deficits arenot the t,ins on analytical and beha.ioural ground e.enthough they are the t,o main components (sa.ing andin.estment) of national income3 Ehen gross domestic sa.ingis smaller than the in.estment to be made then D induced bya high interest rate D inIo, of foreign capital is possible,hich again leads to a similarDsied net inIo, of foreign

goods and ser.ices o.ershooting the e*ports (!l,ell /001)3he author argues that the larger the sa.ingDin.estmentgap- the larger is the inflo, of foreign capital therebyproducing a still larger %3 According to 'abonte andMainen- national sa.ing and in.estment are the cru* of %in a country3 he greater the imbalance bet,een in.estmentand sa.ing the higher the %- ,hich ,ill further bepropelled by budget decits3 Moreo.er- gi.en a pri.atein.estment boom and decline in pri.ate and householdsa.ing- % ismagnied ('abonte and Mainen /008)3

"ne of the underlying contentions in e*plaining the

causality from 4% to % is that if scal decit is financed byprinting ne, money@ it ,ill create e*pansionary effect inthe economy and the demand for more capital andconsumption goods ,ill rise thereby promoting a higherimport3 $n contrast- 4% necessitates a higher interest rate,hich encourages capital inIo,- appreciation of domesticcurrency- loss in e*port competiti.eness and e.entually a%3 Ne.ertheless- empirical studies ha.e sho,n mi*edresults- thatis- countries ha.e diKerent e*periences(Purohit /006: ;6D1)3

'1,1+ 7onetar- /olic- and Trade Decit!*cess money supply (MS) and !R regime are other t,o

.ariables ,hich ha.e relationship ,ith %3 hey are brieIydiscussed here in the light of t,o maor alternati.eapproaches that e*plain the %- namely- elasticity approachand the monetary approach3 According to Ardalan (/00>)-the elasticity approach underlines the role of !R on % and


35/109

4oP adustments- ,hich treats e*ports and imports asdependent on relati.e prices3 4esides- the monetaryapproach discusses the mechanism on the basis of demandfor and supply of money in aneconomy3 he elasticityapproach suggests that the 4 is determined by the o.er orunder.aluation of a currency3 nder 9eynesian system- theauthor argues that de.aluation leads to changes in theprices of domestic goodsagainst the foreign goods implying a change in terms oftrade that brings changes in the 43 Alternati.ely- ano.er.aluation of domestic currency deteriorates the e*portcompetiti.eness and induces more imports from abroadgi.ing ,ay to % (ibid)3 Ci.en the domestic and foreignprices- an increase (decrease) in R!R indicates thedepreciation (appreciation) of domestic currency,hich ise*pected to impro.e (,orsen) the %3 +o,e.er- empirical


36/109

studies ha.e suggested that o.er or under.aluation of acurrency does not necessarily produce e*pected outcomesince e*port and import of a country do depend on priceelasticities of traded goods3

he monetary approach is founded on the famous

Huantity heory of Money postulated by #riedman;0

,hichsuggests that disequilibrium in the current account andUor4oP is essentially- though not e*clusi.ely- a monetaryphenomenon (Ardalan /00>)3 nder monetary approach- thedemand for money;; is considered as stable and anyincrease in MS by the authority ,ill o.ershoot the realdemand for money3 he e*cess money in the system ,ill bedi.erted into goods and bonds (foreign and domestic) andhence the processof equilibrium in money maret ,ill dri.e to current accountandUor trade deficit (+all,ood and Mac%onald ;517 as citedin Purohit /006: ;/)3 +ere- the inherent supposition is that

an e*cess MS ,ill gi.e rise to inIationary pressure thatmaes a countryBs e*ports relati.ely dearer than that oftrading partners3 his ,ill result in loss of competiti.enessand a current account or trade deficit (Purohit /006: ;>)3he critics of the monetary approach emphasie thatmonetaristsB assumption of constant .elocity of moneyalongside *ed real output (due to full employmenthypothesis)@ inclusion of nonDinterest bearing M; (or narro,money) in the denition of money stoc@;/ and the presumedlin bet,een changes in money balances and capital flo,are neither

con.incing nor clear (Ardalan /00>- Nicholas /001b- Purohit/006)3 !.en the argued automatic adustment in trade andcurrent account by the !R under the Ioating !R regimes isquestionable (Nicholas /001a)3

'1,1, Trade (i%eralisation and Trade Decit

$t is argued by neoclassical line of thining that liberalisationof economy is.eryliely to gain benefits from the free tradethat brings competition- comparati.ead.antage- eKicientallocation of resources- higher #%$ Io, and e*ternalities(Fhang and Crabel /00?: ch36)3 $n its report- NFA%

(;555: 16D50) presents an e*planation that ho, a Bbig bangB type liberalisationprocess ofde.eloping countries lead to %3 $n the absence of aselecti.e and appropriately sequenced liberalisationcoupled ,ith eKecti.e measures to promotecompetiti.eness and e*ports- the report states-liberalisation of imports can cause a %3 $n the report-


37/109

instances of Argentina- Folombia- Me*ico- Philippines-hailand and urey ha.e been gi.en ,here a rapidliberalisation ,as follo,ed by large inflo,s of capital-currency appreciationsand a mounting % ending into a crisis (ibid3 p350)3 Similarly Moon-(/00;: />)-

Fhang and Crabel (op3cit3 ch36) ha.e also supported thatthe trade liberalisation policy is one of the reasons of %3%ollar and 9ray (as cited in Moon /00;) ha.e sho,n thatthe % in open economies is larger than in closedeconomies by /305J of C%P3 $n their study- Parih andStirbu (/00?:;1) obser.ed a ,orsening % after liberalisation in manyde.eloping countries of Asia- Africa and 'atinAmerica3


38/109

'1,1* Economic ;rowth and Trade Decit

+igh economic gro,th (!C) in the home country (tradingpartner) ,orsens (impro.es) the % due to higher demandfor capital plus consumer goods and ser.ices from abroad

(home country) ,hile a ,ea !C in trading partners dampenthe demand for domestic e*ports and leads to % (!l,ell/001- NFA% ;555)3 he main e*planation here is thatgro,th needs additional in.estment- ,hich necessitatesinIo, of capital in a country and maes the sa.ingDin.estment (SD$) gap or the % bigger3 4ut Could and Rufn(;557) do not see any relationship bet,een !C and % inthe longDrun3 "n the other hand- NFA% (;555: 65D10) andMoon (/00;) found that % hampers the subsequent gro,thdue to the BbleedingB of in.estible surpluses from theeconomy and other macroeconomic disturbances3 +ence-the causality

bet,een these t,o .ariables is not the same for all countries3 $tdepends oncountryDspecific characteristics lie le.el of de.elopment-sie and structure of the economy- integration ,ith theglobal economy and other macroeconomic .ariables3

'1,1. (ac# of Competitiveness and Trade Decit

Fompetiti.eness is a broad concept ,hich has diKerentinterpretations and methods of measurement3 According to!ealaD+arrison (;555: 8>)- B333 a country is competiti.e if itsindustries ha.e an a.erage le.el of total factor producti.ity

(#P) greater than or equal to that of its foreigncompetitorsB3 he author asserts that #P measures thecombined producti.ities of not only all factors of productionbut also socioeconomic institutions and infrastructuresas ,ell in an economy3 his microDle.el parameter based onproducti.ity and cost helps assess the competiti.eness of acountry3 A country is said to be competiti.e pro.ided itsfirms and industries maintain a.erage le.el of unit costslo,er than its competitors (ibid)3 4ut- the study underlinesthat a country can be competiti.e ,ith respect to technologyand scale of production but not under the costconsiderations3 Moreo.er- the author rightly argues that

competi.eness in terms of cost is not a single indicator andhence producti.ity should also be accounted3 he limitationof cost competiti.eness is such that it suKers from anychanges in international currency and instabilities- if any- intheglobal monetary system3 Regarding the macroparameters of competiti.eness- the degree of economicliberalisation and sound institutional and infrastructural


39/109

frame,or are important to e*hibit a countryBscompetiti.eness that is considered constant in this regard(ibid3 p388)3 hereare .arious indicators for measuring the competiti.eness ofcountries3 hey are discussed in chapter ?3 Purohit (/006:8?)- +ossain (/00?) and Mueller (/007) attribute lac ofcompetiti.eness in the manufacturing sector as one of theimportant determinants of % in $ndia- 4angladesh and theS respecti.ely3

'1,18 (andloc#edness and Trade Decit

he NFA% (/006: ;76) has disclosed that landloced countriesincur %in manufactured goods since they largely rely on the e*ports oflimited


40/109

numbers of goods ,hile they import far more (see #igure>3;)3Another argument is that the high import costs due toe*pensi.e transportation and deli.eryDlag ,ill lead to highercost of production that are targeted for e*ports (ibid)3Cusep (/008) too argues that landlocedness causes

imports to be o.ercharged and e*ports to decline in their.alue3 o quote him- BQit has been calculated that alandloced country e*periences- on a.erage- a .erysubstantial deficit in trade (around 60J) in relation to acoastal country of a similar le.el ofde.elopmentB (ibid)3$nterestingly- Sno, et al3 (/00>) ha.e disclosed thatcompared to their coastal transit countries the landlocedcountries do e*port- on a.erage- 70J less .alue per capita3"b.iously- decreased e*ports result in a %3 +ighertransport costs coupled ,ith unpredictable delays in transithampers the e*port competiti.eness of landloced countriesthereby maing their imports more e*pensi.e ,hich leads

to a smaller trade .olume anddiseconomies of scale (A%4 /007: 7)3 #ocusing on the costsof landlocedness-Ar.is et al3 (/006)- emphasie- BQ,eapositioning in the global maret entails lo, trade andpre.ents most ''%Fs from reaping scale economies3B

'1,1< /olitical nsta%ilit-= Con>ict and Trade Decit

he issue of causality bet,een political instability (P$) and% is debatable3 he P$ can arise from many sources liechanges in current po,er structure- social disorders-insurgency- economic crises- ineKiciency of go.ernment-foreign interestsUinter.entions and so on3 $n Nepal amongothers- the Maoist insurgency- arguably one of the internalshocs remained a main determinant of P$ for a decade3%uring ;558D/007- there ,ere t,el.e prime ministers inpo,er that best pro.ides a glimpse of P$ in the country3

According to 9oirala et al3- P$ is liely to increase the %since businessmen loo for high prot by importing moregoods ,hen there is policy uncertainty and go.ernment isin defence of its continuity3 he argument is that the importis an easy means to meet domestic demand rather thanproduction at home (9oirala et al3 /008:

71)3 he authors ha.e sho,n a positi.e relationship bet,een P$ and% intheir regression model3 9umar (/008: /0D/;) hase*emplied the impact of NepalBs conflict as the closingdo,n of industries and enterprises- declining tourism andhence surge in imports and a decit in trade3 hecausality bet,een conIict and % is most liely an


41/109

empirical question rather than a theoreticalunderpinning3


42/109

Chapter +Structure and Direction of )orei$nTrade of

Nepal

$n this chapter- eKorts ha.e been made to present thestructure and direction of foreign trade of Nepal3 hecomposition of import and e*port basets is taen intoconsideration to analyse the structure ,hich can ha.edirect andUor indirect relationship ,ith the ongoing %3Similarly- the direction of foreign trade is discussed ,iththe help of trade balance positi.e or negati.e3

+1& Trade Structurehe commodityD,ide data that are a.ailable (since ;557) for e*port(see able

>3; and >3/) and import basets (Appendi*: AD4) of Nepal displaythat there are limited number of manufacturing goods in theformer ,hile the latter contains .arieties of capital and consumergoods3

Table .1!"por#s of So$e %aor 'o$$odi#ies #o ndia (n %illion upees)

#$ricultural products %!& *%& +% +"**! *+

orest .roducts ** +&* *&& **! !*

Ghee (/e$eta0le) &! &&%+ !*+" *""! &+%"*

1ute Goods & %"* %+ "&*! !

2hread na *% !& &"*! +

2ooth .aste !& + *+! +&*! !&

.ol3ester 3arn &"& !! &++ ""+! "*

2e4tiles na % !& *&"!

5inc sheets na &" & "%! +!"

6opper 7ire rod na * +"! "+! &%

1uice na %%" "*+ &*%! !%

.lastic utensils na ! +*+& !!!! *%%

8thers *&* *"&& **"&& !&&&! &+

To#al 1*+,+.6 -51.* 596.* 5-,+-.1+ -961.6

Source: 9B, ';uarterl3


43/109

"ut of total e*ports to $ndia- the combined share ofagricultural and forest products are e*hibiting anincreasing trend3 hough there are some doens ofmanufactured items that are e*ported to $ndia- fe, of them

ha.e maintained a signicant share in the total transaction3he e*port share of .egetable ghee-


44/109

ute goods and thread hold more than /0J of the totalshare3 Products lie toothpaste- polyester yarn- te*tiles-inc sheets- plastic utensils and uice are other main e*portitems3 After the introduction of ne, bilateral trade treaty,ith $ndia in ;557 there ,as a remarable increase in the

e*ports of some manufacturing and agricultural products34ut alongside the re.ision of the treaty in /00/ byintroducing some restricti.e quota pro.ision (seeAppendi*D!) for some Nepalese products the gro,th rate of e*portsdeclined3

NepalBs e*ports to other countries (other than $ndia)contain lo,Dtech products3 Eoollen carpets- readyDmadegarments (RMC) and pashmina together hold more than78J of the total e*port to these countries3 +o,e.er- thee*ports of RMC and ,oollen carpets ha.e shrun since themid ;550s (able >3/)3

Table .,!"por#s of %aor 'o$$odi#ies #o /#0er 'oun#ries (n %illion upees)

Items27o-3ear 2otal

%%*-%" %%&-%% !!!-! !!-! !!+-!

Woollen 6arpet

ead3made Garments

"* %** +&!+& !%%" "!"+

%"!+ *++ !%"" ++! &"

.ashmina na **! ** " *"*

=andicraft (>etal and Wooden) "" %* +*"" %"& !"

Silver7are and 1e7elleries *+% +* +&* "*+ *+*

.ulses &** !!& "" +%* %&

9epalese .aper ? .aper .roducts +% &%% %" +* +%*&

To#al 61,9.* 51-*-.6 *61,.5 *66*., 9+.,

Source: 9B, ';uarterl3


45/109

e*tent of NepalBs dependency on $ndia3Accordingly- most ofthe Nepalese imports from other countries are relati.elypriceDinelastic manufactured goods3 "ut of them- thread-ra, ,ool and sil for the production and e*port of RMC-,oollen carpet and pashmina are mentionable3 'ie,ise-gold and sil.er- petroleum- machineries- electronics-transport equipments and parts are other ey imports3 Someof them are essential capital goods ,hich enhance theproducti.e capacity of the economy


46/109

and are liely to strengthen the future e*ports of the country3 And-someothers are purely consumption and lu*urious goods ,hich generallypropel the%3

+1&1& 4verseas Trade Composition of Nepal

Apart from $ndia NepalBs o.erseas trade is mainlyconcentrated toAmerica- !uropean nion (!) and Asiancountries3 "ther !uropean countries outside the ! holdless ,eight in terms of .alue3 Similarly- trade ,ith Africa is.ery negligible ,hile in case of "ceania- the e*port is quitelo, but the share of import and the % is noticeable (able>3>)3

Table .

'o$posi#ion of /verseas Trade of Nepal ()

Destination


47/109

+o,e.er- the total .alue of e*ports to these countries hasbeen continuously falling ,hereas imports ha.e sho,n ami*ed pattern of falling


48/109

and rising3 $t ,ill not be a mere coincidence as totalimport has suddenly increased in /007 the end of tenD

year long armed conIict in the country3

+1&1' Num%er of /roducts Eported and mported

Measured in number of commodities in inds- the imports ofNepal until /00? is almost double than its e*ports3 #rom/008 on,ards- the gap is declining ho,e.er (#igure >3;)3 $tse*ports are not as di.ersified as imports- and to a greate*tent- Nepal depends on imported goods3

Figure .1Nu$ber of 3roduc#s4 !"por#s and $por#s

Source: WB, 'World 2rade Indicators-!!&'

+1' Direction of )orei$n Trade of Nepal

he sie of total foreign trade in terms of C%P has beenfollo,ing an up,ard trend until ;556 but after ;556 it hasbeen declining contrary to trend of % (#igure >3/)3

Figure .,%ove$en#s of To#al Trade and Trade Balance

2otal 2rade ( ri$ht scale )

%"! %&! %%! !!! !!3ear

2BG?S 2otal 2rade (C of GD.)

Source: WB, 'WDI-!!"'

G?S(CofGD.)

-!

-,

!

!

+

!

,!

!

2rade

(CofGD.)

-,

!


49/109

As the share of e*ports and imports ,ent do,n for some years afterthe mid;550s- the total trade also follo,ed a similar path3 #all inimports ,as stronger than the e*ports3 he reasons arediscussed in chapter ?3 hroughout the study period the

direction of 4 remained al,ays negati.e3 here are somehistorical e.ents in the country ,hich ha.e influenced itse*ternal sector3 Nepal adopted the economic liberalisationpolicy in ;51?U18 ,hich ,as further speeded up after ;55;3$n ;515D50- $ndia imposed economic sanction on Nepal,hich had had detrimental impacts in Nepalese economy(4lanchard et al3 /000: /?6- Shrestha /006)3 A ne,industrial policy ,as in eKect in ;55/ ,hich ,as acomplement to the e*ternal trade3 'ie,ise- Nepal and $ndiaestablished afi*ed !R regime in ;55> and all foreign currencies ,erecrossDpegged ,ith $ndian currency3 "n the other side- the

Maoist insurgency started in ;557 ,hichlasted in /0073%uring the insurgency- the economic en.ironment of thecountry ,as nonDconduci.e- e.en damaging (4hattarai/008:/0)3 he countryBs economy faced both the internaland e*ternal shocs due to massacre of the Royal family inNepal and the terrorist attac in the S in /00;3 #inally- in

April /00? Nepal accessed the membership of E" ,hichfurther opened the door for imports and imports3 heseissues are reiterated in chapter ?3

"n a.erage- % in goods is sho,ing an increasing trendafter ;567 e*cept mild impro.ements in some years (#igure

>3>)3 Nepal has e*perienced a surplus in ser.ice accountsince ;5673 $t ranges from one to four per cent until ;55>and post /00/3

Figure .Trade Balance in Goods and Services

Source: WB 'WDI-!!"'

After ;55? the tourism industry ,as booming until it peaed

in ;556 promoted by the national campaign B&isit Nepal


50/109

;551B3 $t has sharply declined after ;555 asthe conIict inthe nation intensied and security condition deteriorated3he State of !mergency imposed by the go.ernment and theRoyal massacre are t,ostrong causes- among others- forthe decline of ser.ice trade3 he trade


51/109

surplus in the ser.ice sector is not suKicient to compensatethe total decit in goods- ho,e.er3 he combined tradebalance in goods and ser.ices is again negati.e due to thehigher deficit in goods3 $t is distinct that the combinedtrade balance is follo,ing the mo.ement of % in goods3

Ne.ertheless- in late;550s a signicant surplus in ser.ice account hascompensated similarDsie deficit in goods3

Accordingly- from ;567 to /00;- the income account,as positi.e and higher than the surplus in ser.iceaccount despite a number of oscillations (#igure >3?)3

Figure .*Trade Balance in Goods and Services (co$bined) and nco$e

Source: WB 'WDI-!!"'

$t sharply declined after ;51/ as there ,as a globalrecession in thatyear3 he recessionary effect hit thissector in the succeeding years3 After ;51? the countryinitiated liberalisation of economy and the income accountremained almost ero in those initial years3 $t ,asmeasured nearly 6J of C%P in /000 ,hen remittances,ere soaring3 $nterestingly- it ,ent negati.e after /00;3he impact of SeptemberD;; (terrorist attac in the S)could be one of the possible ans,ers for the do,nturn in

,orsening income balance3 %uring the study period thea.erage net income ,as /3?J of C%P ,hich ,as oKsettingsome of the decit in merchandise trade3 +o,e.er- theoscillating nature of income account does not resemble itas a reliable source for the Nepalese economy3

he o.erall balance of trade in goods- ser.ices andincome is also negati.e and follo,ing the mo.ement ofdeficit in traded goods (#igure >38)3 $t has- ho,e.er- reachedaround ;8J of C%P after /00/ mainly due to the negati.eincome balance in that period3


52/109

Figure .5Trade Balance in Goods Services and nco$e ('o$bined)


+1'1& 7ovement of Trade with ndia and 4ther Countries

$ndia ,as a main destination for NepalBs e*port until ;518but it did not remainso after mid ;550s to late /000 (able>3?)3 After the economic liberalisation of ;518 and ne,political system in ;550- NepalBs e*port started e*pandingto Bother countriesB3 $n the pea period (/00;) of armedconIict in Nepal- and E" membership in /00? the e*portsto other countries ha.e narro,ed do,n3 As the M#A quotaended in /00?- Nepal too suKered from it (Shaaha /001)3

As a result- the e*port to other countries declined from/008 on,ards3 he decline in imports from other countriesduring /00;D08 can be the ne, pro.ision of petroleumimports from $ndia3

Table .*3eriodic Trade Balance (19-6+5)

(In >illion :s)

.eriod


53/109

+1'1' Direction of Defcit Compared to Tradin$ /artners

able >38 supplies the direction of deficit compared to someey trading partners and neighbouring countries3 here are4angladesh- Paistan and Sri 'ana incurring a % as big

as the magnitude in Nepal3 +o,e.er- diKerences aredistinct in their direction- for e*ample- the trend of decitsin 4angladesh and Paistan is decreasing in e.erysuccessi.e period ,hile Nepal is e*periencing an up,ardtrend3

Table .5Trade Balance (Goods and Services) in 7ifferen# 'oun#ries ( of G73)

.eriod %"*-&! %&-& %&*-%! %%-% %%*-!! !!-!+

9epal -++ -& -! -!& -! -+

Ban$ladesh -!! -% -" -+ -% -

.akistan -! - -& - -* !

Sri anka -"* - -! -!! -& -"

India - - - -!+ -+ -

6hina -! -! -!+ +

German3 -& -% -!* -!* +" &

1apan !+ & % !%

Anited States -!" -* - -!% - -+

Source: WB, 'WDI-!!"' and author's calculation

$n the latest decade- NepalBs % as percentage of C%P isnearly double of 4angladesh3 $n ;567D10- NepalBs position,as t,ice as better than 4angladesh3After /8 years (/00;D0?)- NepalBs position is t,ice as B,orseB than 4angladesh3Sri 'ana ,as on the same path as Nepal until ;51;D18 butit has been impro.ing its position after ;517D503 Paistansho,s a similar trend as Sri 'anabut the degree ofimpro.ement is far better than all the countries on the list3$ndia- on a.erage- sho,s smallest sie of decit amongSouthAsian countries3 Accordingly- Fhina e*hibits negligiblesie of % until ;517D503 After;557D00 ho,e.er- it enoys atrade surplus3

'ie,ise- Cermany has sho,n a rapid progress in its43 Furrently- it is one of the biggest countries ha.ing atrade surplus3 Gapan has al,ays had a trade surplus since;567 to date3 he SA ,as relati.ely better oK in ;567D10and ;55;D58 ha.ing a % of quite a small sie3 $t has sho,nan increasing trend in rest of the period3 o conclude-NepalBs ongoing trend of % and its sie is criticalcompared to its neighbouring countries and tradingpartners3

+1'1+ Trade Defcit in ;oods: ndia and 4ther Countries


54/109

he % of Nepal is .olatile since ;578 (#igure: ;3; L >37)3ntil ;565- the deficit (in merchandise) ,ith $ndia ,ashigher than all other countries (#igure>37)3 %uring ;510D;55; and ;55>D/00;- the decit ,ith $ndia laggedsignicantly behind the other countries3 After ;510- as Nepal ,ase*panding its


55/109

trade relation ,ith ne,er countries the % ,ith $ndiado,nsied along ,ith the .olume of trade3 #urther- in thatperiod the pre.ailing trade treaty ,ith $ndia e*pired3

Figure .6

Trade Balance 8i#0 ndia and /#0er 'oun#ries

Source: 9epal Rashtra Bank, ';uarterl3 36- it is apparentthat the a.erage gro,th rate of import has led the e*portgro,th3 he a.erage gap is either ,idening or maintaininga constant pattern o.er successi.e years leading to a ne.erDending deficit3 he

noticeabledecline of both .ariables in

;551 ,as due to decline in the imports of traded goods and


56/109

do,nturn in the ser.ice sector3 $n /00;- there ,as a Stateof !mergency in the country ,hich pushed bac the tradesector for someyears3


57/109

Figure .-!"por# and $por# (Goods onl) Nepal

Data Source: WB, 'WDI-!!"'

+1'1* Current "ccount 2alance

he FA of Nepal is influenced by the magnitude anddirection of decit in traded goods3 $t has remainednegati.e throughout ;566D/00; (#igure >31)3A sharpimpro.ement in the FA balance can be noticed since ;5513$t has gained positi.e sign after /? years in /00/3 $ncreasingtrend of remittances and surge inforeign aid can be t,opotential causes of this impro.ement3

Figure .'urren# :ccoun# Balance



58/109

+1'1. Nepal?s Trade /olic-

NepalBs trade ,as limited to $ndia and ibet (Fhina) until;570s3 $n the third .eDyear plan (;578D60)- NepalBs priority,as to di.ersify the e*port ,hile substituting the imports

,ith the application of high tariff barriers and quotas3 heobecti.es ,ere to narro, do,n the % and promoteindustrialiation and di.ersication of the economy(SAE!! /006)3 4esides- the go.ernment of Nepal ,asadopting a dual !R system- a cash subsidy programme- dutye*emption on e*portable commodities- simplication oflicensing and custom procedures3 Mean,hile- introductionof a ne, industry and trade policy ,ere additional effortsmade by the go.ernment (ibid)3

Nepal introduced its rst trade policy in ;51>3 he eyfeatures of this policy ,ere delicensing of e*ports- remo.alof income ta* on e*port earnings- introduction of duty

dra,bac system- harmoniation of custom procedures- andestablishment of National !*port rade %e.elopmentFouncil (9hanal et al3 as cited in SEA!! and AAN /006:;/D>)3 rade Policy ;55/ is thought to be a milestone inNepalBs history of trade policy3 $t ,as the outcome ofgo.ernmentBs ongoing effort on economic liberalisation3 $thas clearly emphasied on the promotion of internal ande*ternal trade@ more roles to pri.ate sector@ di.ersicationof foreign trade in terms of commodities and destinations@realiation of bac,ard linages- enhancement ofemployment through trade and reducing the ongoing tradeimbalances (ibid)3 Moreo.er- rade Policy ;55/ remo.ed any

import ta*es on ra, materials- e*emption of income ta* onthe e*port earnings- no licensing for trade;?3 $t has acceptedthe StateBs role as a catalyst and ad.ocated for the massi.ein.ol.ement of pri.ate sector3

$n this regard- the policy put forth the plan ofpri.atising public sector trading enterprises and ,asimplemented partly3 Still- there are a fe, big tradingcorporations under the State control3 $t has pursuedpolicies to attract #%$ through a liberal industrial policy3$n order to maintain coherence among policies- necessaryreforms ,ere made infiscal- monetary and foreign e*change

policies3 Specifically- the pro.ision of full con.ertibility intrade and ser.ices sector ,as an encouraging factor3 he$ndian currency is fully con.ertible in the country3 Moreimportantly- it has not only agreed to implement effecti.elyall the bilateral and multilateral e*isting trade treaties butbringing up the ne, ones into place so as to promoteforeign trade3 hough e*port promotion is the core of thispolicy- it has realied and categoried the need of imports inorder to Iourish the economicde.elopment3 $t focuses on the sustained foreign trade sector bynarro,ing


59/109

do,n the importDe*port gap3 here are no morerestrictions to import ra, materials- consumer goods-industrial machinery- and ser.ices3


60/109

Chapter ,"nal-sis of Causes of Trade Decit ofNepal

$n order to ans,er the research question the analysis has beenframed in lightof the theories discussed in chapter /3 $t captures both thee*ternal and internal sources of %3 Specically- e*ternalshocs- budget decit (scal policy)-e*cess MS and !R misalignment- direction of economic gro,th-tradecompetiti.eness- economic liberalisation- landlocedness- andpoliticalinstability are considered as main focus .ariables3

Fomparison of some rele.ant statistics of NepalBsneighbouring countries and trading partners has also beenmade as a complement3 Since $ndia is a neighbouringcountry and a main trade partner- its greater inIuence onNepalese 4 is e*amined depending on a.ailabledata3

,1& Eternal shoc#s and Trade Defcit

!*ternal shocs (mainly from demand and price)- as alreadydiscussed in section/3?3?- play a role in the trade andcurrent account balances of a country3 %epending upon thenature of e*ternal shocs- trade balance of a country is

e*pected to change its direction and magnitude3 #igure ?3;e*hibits the pattern of e*ternal demand shocs emerged inthe ,orld economy and its resultant impact on the e*portsector of Nepal;83 Since readyDmade garment (RMC)-,oollen carpet and pashmina;7 are three maor items ofNepalese e*port to o.erseas countries- they ha.e beenchosen as focus.ariables3

Figure *.1!"#ernal 7e$and S0oc;s (


61/109

Source: 9B ';uarterl3


62/109

!*port of Nepalese carpet and RMC ,as rapidly increasinguntil ;55>3 4ut as there ,as an e*hibition in Cermanyregarding the use of child labour in maing of Nepalesecarpets- and its documentary broadcast by Panoramatele.ision ne,s (in April ;55?) the demand for ,hich

drastically declined in!urope and the S (N!SP!F as cited in Fharabarty /006:6>)3 he demand shocs in Nepalese ,oollen carpet e*portcan best be understood by the follo,ing statement:

B"ne of the main reasons of the carpet shoc in ;55?D58 ,asdue to anti child labor demonstrations in Cermany and otherimporting countries3 Accusations by national and internationalnonDgo.ernmental organiations almost led to a completeboycott of NepalBs carpet e*portB (Fharabarty /006: 6/)3

Nepal could not maintain its fast gro,ing e*ports ofcarpet thereafter

since Cermany and the S ,ere the t,o biggest importers ofNepalese carpets3 hroughout the second half of ;550s- the,orld and S economy ,ere booming- and the !ast Asianeconomies ,ere stepping to,ards reco.ery despitethe crisisin Russia and Me*ico3 heir positi.e eKect can be seen in thegure3 !*ports of both the RMC and ,oollen carpetsreached their pea in those years3 he incident of September;; and its ine.itable impact in the S and ,orld economy isquite clear in the gure3 !*ports of all the three eyproducts ha.e sharply gone do,n due to decreased demand3hough the

e*port of RMC climbed up in /00/ it could not sustain thesame pace and position due to the ne*t do,nturn in the,orld and the S economy /00>3Another demand shocsfor Nepalese e*ports appeared in /008 ,hen the Multi#ibre Agreement ,as terminated in %ecember /00?3 hedecline in the e*ports of RMC can be seen in #igure ?3;3

4esides- the impact of these demand shocs can beseen e.en in the

o.erall e*ports and imports to other countries but not necessarily to$ndia(#igure ?3/)3

Figure *.,!"#ernal 7e$and S0oc;s4 ndia and /verseas 'oun#ries (:ll 'o$$odi#ies)


63/109

Data Source: 9B, ';uarterl3


64/109

he e*ternal demand shocs resulting from the BcarpetshocB in ;55?U58 and SeptemberD;; ,ere strong enough toinfluence the total e*port to o.erseas countries@ ho,e.er-they produced lo, or no impact on the e*port to $ndia3 heimpact of termination of M#A is also seen in the aggregate

e*ports to o.erseas countries3 he demand shoc in $ndianmaret for Nepalese products ,as apparent in ;515D50,hen $ndia imposed an economic sanction on Nepal3'ie,ise- the demand for four ey commodities of Nepal in$ndia ,as largely contracted due to the restricti.e quotapro.ision in the rene,ed bilateral trade treaty /00/3Mohanty (/00>) also sees the role of trade and transit treatyon $ndiaBs trade surplus ,ith Nepal3 o sum up- demandshocs are hea.ier and responsi.e to the e*ports to o.erseascountries3 hese shocs are relati.ely less responsi.e incase of $ndia3 #urthermore- it is possible that the impact ofthose e*ternal shocs could ha.e retained some le.erage

from the domestic BshocsB lie the royal massacre in /00;and the Maoist insurgency during ;557D/0073

Another face of e*ternal shocs is price shoc that canhit the trade balance of a country3 he impact of priceshocs in Nepal- as in other countries- is generallytransmitted from the rise in the price of petroleumproducts3 hough terms of trade is a good measure toe*amine the eKect of price shocs- due to una.ailability oflonger timeDseries data- $ ha.e chosenannual consumer price indices (FP$) of Nepal- $ndia- the Sand the ,orld as a pro*y3 hese indices ha.e been plottedagainst the a.erage price of crude oil

inthe ,orld (#igure

?3>)3

Figure *./il 3rice S0oc;s nfla#ion and 7irec#ion of Nepal=s Foreign Trade

%"! %&! %%! !!! !!Eear

.etroleum .riceWorld (AS @ 0arrel) 6.I9epal

6.IIndia 6.IAS

6.IWorld

Source: I> 'International inancial Statistics 6D-8>' and WB, 'WDI-!!" '

leum.riceWorld(ASG@0arrel)

+!

*!

&!

!!

!

+!

!

,!

!!

,!

sumer.riceInde4


65/109

$nIation in the ,orld and Nepal has not sho,n anoticeable shift in their inflation cur.es despite theoscillatory prices of crude oil including the biggest


66/109

hie in ;565D;510 and t,o other soaring peas in /000 and/00?3 he inIation in $ndia ,as almost the same ,ith Nepal,hile it ,as remarably high in theS until mid ;550s3 $t is true that the inflation in Nepal ,assignificantly higher

than the ,orld until ;55?3 #rom ;558 on,ards the gapbet,een them is small3 Ci.en the historic ;>>J rise in ;565and another ;1J rise in ;510 in the price of petroleum- therate of change in FP$ of Nepal is small3 Some possiblereasons could be the limited e*tent of integration (in ;565D10) ,ith the global economy- smaller sie of e*ternal tradeand foreign dependence- and smaller demand for petroleumproducts3 $nterestingly- despite the sharp fall in oil price in;517 and ;551 the ,orldBs as ,ell as NepalBs inflation hascontinued to rise asusual3 'ogically- Nepalese e*ports dueto higher rate of inIation at home thanin the rest of the,orld are less competiti.e and hence % is not a surprise3

Accordingly- as the ,orld and domestic inIation are almostthe same after ;558- there cannot be seen a uniformimpro.ement in the ongoing % (#igure ?3?)3

Figure *.*n#erna#ional 3rice of 3e#roleu$ and Trade 3erfor$ance of Nepal


Ci.en the signicant rise in price of oil- the amount ofimport bill has naturally gone up in most of the cases lie;565D10- /000 and /00?3 "n the other hand- irrespecti.e ofa fe, e*ceptions- e*ports ha.e either contracted or goneinsignicant changes3 he corresponding increase in %after the oil price rise is .i.id in the years ;510- /000 and/00? but surprisingly % has impro.ed in ;555 despite >6Jrise in petroleum3 $ncrease in oil price has not al,ays andimmediately led to proportionate rise in %- for e*ample- in;565-;516 and ;5503 $t is clear from the gure that the inIationbrought about by oil price is immediately hitting the

import baset but not strongly the e*port baset3 his


67/109

response is- ho,e.er- enough to produce a % since thegap bet,een them ,idens3 And- for a fall in oil price- %has either declined (in;551) or stopped from ,orsening (as in ;517)3 'ie,ise- for arelati.ely smaller


68/109

fall in oil price as in ;511- the % has not been pre.entedfrom rising3 o sum up- the e*ternal price shocs producedby the surge in petroleum price- on a.erage and dependingupon the magnitude of rise- is ,idening the ongoing trend of%3 +o,e.er- in cases ,ith relati.ely smaller price hies-

these shocs are not able to produce signicant differences3

,1' 2ud$et Decit and Trade Defcit

he relationship bet,een budget decit (4%) and %(also no,n as t,in deficits) in Nepal has been plotted in#igure ?383 $t is hard to nd any unidirectional orbidirectional relationship bet,een these t,o .ariables inNepalese conte*t3

Figure *.5T0e T8in (Budge# and Trade) 7efici#s

2rade Deficit ( :i$ht Scale )

%&! %&, %%! %%, !!! !!,Eear

Bud$et Deficit (C of GD.) 2D (C of GD.)

Data Source: >o, 9epal, '# 6ollection of Bud$et Speeches of 27ent3-si4 Eears'"

(in 9epali) ? WB,

'WDI-!!"'

here are limited cases ,here an increase in 4% haspushed up the trade deficits or .ice .ersa3 #or e*ample-from ;51;D1> and /00/D08 they ha.e follo,ed similar

direction- regardless of magnitude3 $n other cases- they aree*hibiting the re.erse directions- for e*ample- ;518D11-;55/D5? or ;558D513 'ie,ise- the 4% during ;51/D50 andduring ;557D/008 is fairly stable e*cept some e*ceptions34ut- the % is more .olatile3 After the stabilisation policy in;51?- the 4% has impro.ed for some years but the % continued toscale up3$t can be seen that 4% has hea.ily controlled after ;55>-ho,e.er- the trade deficit ept on s,inging3 $n ;550- there,as a ne, political system (and go.ernment) in thecountry- ,hich adopted an e*pansionary fiscal policy butthe % remained almost same3 $n sum- 4% in Nepal- do not

e*hibit a strong

*

d$etDeficit(Co

fGD.)

"

&

%

&

!

+

deDeficit(Co

fGD.)

*,


69/109

and con.incing cause for the ongoing %3 heirmo.ements are hard to predict and contradictory to thepre.ious findings of similar nature3

he role of scal policy can also be e*amined from the sie anddirection

of gross domestic sa.ings (C%S) and in.estments3 Asalready discussed in chapter /- the gap bet,een them(Sa.ing and $n.estment) resembles the e*act sie of the %(in Coods L Ser.ices) ,hich is distinct in the graph (#igure?37)3 $t is ob.ious from the gure that the gross capitalformation has al,ays been higher than the C%S duringthe study period3

Figure *.6Savingnves#$en# Gap and Trade Balance


$n the gure ,e notice that these t,o .ariables areneither al,ays follo,ingthe same direction nor maintainingthe same gap3 $n some years- in.estments aremoredominant to determine the sie and direction of % ,hile inothercases sa.ings are more dominant3 #or number ofoccasions- they ha.emaintained the same gap therebyeeping the % fairly stable3 Fompared toin.estment- thesa.ings in the economy are found either decreasing or

constantirrespecti.e of some e*ceptional years3 $t is fair toargue that the negati.esa.ings in the public sector (4%),as one of the possible e*planations fordecreasing or lo,C%S3 he a.erage C%S (;567D0?) is around ;/J ,hich istoolo, to cope ,ith the a.erage gross in.estment of /; percent3

,1+ Ecess 7one- Suppl- and Trade Defcit

As discussed in chapter /- monetarists belie.e that e*cessMS has direct and positi.e relationship ,ith trade andcurrent account decit3 #igure ?36 sho,s the trend of

e*cess MS;1 and 4 during ;567D/00? in Nepal3 #rom the


70/109

graph- it has been clear that these t,o .ariables in theconte*t of Nepal are not displaying uniform or consistentmo.ements3 #or e*ample- gi.en the increasein e*cess M/ (or broadDmoney);5 for ;> occasions- (;565- ;51/D1>-;516- ;550-


71/109

;55?- ;557D56- ;555D00 and /00/D0?) the % has increased;0 times ,hile it decreased in > occasions3 Similarly- gi.en adecline in e*cess M/ during ;8 occasions- the % hasincreased and decreased se.en occasions each but remainedunchanged once3 #urthermore- the magnitude of change in

the % is not same for e.ery change in the e*cess MS/0

3

Figure *.-!"cess %one Suppl and Trade Balance

%"! %&! %%! !!! !!Eear

2rade Deficit C of GD. $ro7th (C)

Data source: 9B, ';uarterl3 D;51>- Nepalese Rupee (NRe),as dual pegged ,ith $ndian Rupee ($Re) and the S dollar3

#rom ;55> on,ards- the NRe has been pegged ,ith $Re3 Allother foreign currencies are crossDpegged ,ith $ndiancurrency3 here is full con.ertibility for $ndian currency,hile other currencies are con.ertible for specific purposes3he full con.ertibility ,ith $ndian currency has arguablypromoted more trade ,ith $ndia3 As NepalBs ey e*portproducts are based on imported ra, materials- anydepreciation of NRe ,ith the $Re can ha.e damaging effectto NepalBs e*port since they ,ill raise the cost ofproduction3 #igure ?31 depicts the trend of o.er orunder.aluation of real e*change rate (R!R)/; and tradebalance ,ith $ndia3

radeDe

ficitCo

fGD.

-,

-!

-,

!

-!

-!

!

!

cess>$ro7th(C)


72/109

Fontrary to the longer oscillations and lesser .olatility of4- the R!R has smaller oscillations''but relati.ely more

.olatility3 Stated other,ise- the magnitude of change in4 is higher than the R!R3 #or e*ample- gi.en theunder.aluation in ;566- the deficit scaled by almost ;7

percentage points3 Similarly in ;51?- decit soared by 6percentage points despite the under.aluation by 7percentage points3

Figure *.%ove$en# of ! and Trade Balance 8i#0 ndia

(

Data Sources: 9B, WB, 'WDI-!!"' and author's calculation

he positi.e impact of under.aluation can be easily noticed in ;517-;511-;55?- ;558- ;556 and /00?3 he o.er.aluation and resultant,orsening of % are distinct in the years ;55/ and /0003Ci.en a negati.e and ,ea correlation coefcient (D03;1) itis easy to understand a nonDlinear relationship bet,eenthem3 Saruni (/006) in case of anania had found thatunder.aluation of R!R ,orsened the %3 And- in case ofNepal- %e.ota (n3d3) found no signicant role of R!R inpromoting the e*port3 #rom the discussion- $ ,ould argue

that the !R is not a strong factor to be attributed as one ofthe causes of the % in Nepal3 $t ,ould be a ,ea policymeasure to correct the NepalD$ndia %3 he effect ofo.er.aluation or under.aluation of R!R depends on gi.enelasticity (greater or lesser) regarding the demand forimports and e*ports (hir,all as cited in Purohit /006: /0)3

#igure ?35 captures the relationship bet,een the R!Rmo.ement and 4 ,ith other countries3 +ere too- the t,otrend lines of 4 and R!R e*hibit diKerent patterns3%espite the smaller magnitude of o.er and under.aluationof domestic currency- 4 has been- as in the earlier case-s,inging ,ithout a consistent pattern3 A small correlation

coeKecient (0307) has indicated a nonD linear relationship


73/109

bet,een them as also displayed by the figure3 is too lo, tosupport a linear relationship3 Ne.ertheless- thisrelationship contradicts ,ith


74/109

similar research- for e*ample- FalderVn et al3 (;555) ,hileanalysing the FA deficit of de.eloping countries found thatappreciation (depreciation) of local currency increases(decreases) the FA deficit3

Figure *.9%ove$en# of ! and Trade Balance 8i#0 /#0er 'oun#ries

Data Source: WB, 'WDI !!"' and author's calculation

#rom the discussion- $ ,ould argue that the !R has lessinIuence on the 4 ,ith other countries3 $t is possible thatdue to the elasticity eKect of goods in e*port and importbasets- the po,er of R!R is not eKecti.e as it ,ould be3"r- it is equally liely- as %e.ota (n3d3) argues- that !R isnot a proper means to chec % for Nepal because of itslarger import and a smaller e*port base3 +ence- !R couldnot be a strong policy tool to boost the e*port of Nepal ando.ercome the decit3

Notably- the 9athmandu Post (/ Gune /00>)- analysingthe ongoing !R regime- states that an automaticappreciation of NRe ,ith the S dollar resulting from theappreciation of $Re is damaging for Nepalese e*ports3 $ncontrast- corresponding de.aluation of NRe is not easy toraise e*port competiti.eness since they are .ery liely toproduce costDpush inIation in the economy3

,1* Trade (i%eralisation and Trade Defcit

Ci.en a tradeUC%P ratio of nearly 80J- an a.erage tariK rateof around ;?J and almost no nonDtariK barriers maesNepal as one of the most liberalised andtradeDdependenteconomies in South Asia ($#EC /00>: 1)3 he process ofeconomic (and trade) liberalisation started in ;518 andgeared up after ;5503 4y/00? (the year of E" membership)- Nepal continued to broadentheopenness and pushed do,n tariK ,alls and other inds of

import restrictions3 +o,e.er- ,hen the domestic


75/109

manufacturing sector is in its infant stage and the country isforeignDsource dependent for de.elopment finance- the costsof


76/109

liberalisation may out,eigh its benefits3 After ;55;- boththe e*ports and import increased significantly comparedto the pre.ious decade but it could not minimie the gapbet,een them (see #igure >37)3

able ?3; sho,s NepalBs a.erage periodic 4

before and after the liberalisation3Table *.1

Trade Balance Before and :f#er >iberalisa#ion

.eriod #vera$e 2rade Balance in G ? S (C of GD.) emarks

%"*-&+ -* Before li0eralisation

%&-% -! st

phase of li0eralisation

%%-!+ -!" nd

phase of li0eralisation

!!-!" -&* #fter W28 mem0ership

Data Source: WB, 'WDI- !!"', 6BS (9epal)

he increasing trend of % after the economic liberalisationis distinct from thetable3 !.ery successi.e phase ofliberalisation in Nepal has been follo,ed by remo.al orminimiation of tariK and nonDtariK barriers- encouragedforeigncapital inflo,- and pri.atiation of publicenterprises3 he positi.e relationship bet,een economicliberalisation and the % is .isible from the table3 +o,e.er-,e cannot undermine the ancillary impacts of other factorssuch as Maoist insurgency after ;557 ,hich demolished

many economic infrastructures of the country3 'ie,ise thefrequent blocades and NepalD bandh during the royal coupregime (/00/D08) could also be responsible to somee*tent3$n sum- there could be cumulati.e role of liberalisation andpolitical instability for the gro,ing % after ;55/ but in thefirst phase of liberalisation (;518D5;)- there ,ere no such

.isible factors to charge e*cept theliberalisation3 he e*periences of anania and other countries (seesection /3/)also sho, that % ,orsened after liberalisation3

$n contrast- able ?3/ presents the 4 in neighbouring

countries that does not re.eal the same story3 he a.erage% in 4angladesh and Paistan afterthe liberalisation has remarably declined in both phases,hereas in case of $ndia- it has increased (decreased) inthe rst (second) phase3 +ence- the generalisation- on thebasis of a.erages- has become a comple*ob3Ne.ertheless- there are t,o important diKerences in thiscomparison3 #irstly- the reference periods are not the same,ith Nepal3 Secondly- the nature and degree ofliberalisation (,hich is beyond the scope of this paper)plays a.ital role to reach an inference3


77/109

Table *.,Trade Balance in Neig0bouring 'oun#ries4 Before and :f#er >iberalisa#ion

.eriod (phase) #vera$e 2B in G ? S

(C of GD.)

emarks

Ban$ladesh post-li0eralisation

India post-li0eralisation

.akistan post-li0eralisation


,1. Economic ;rowth and Trade Defcit

he !C and 4 o.er the years of Nepal ha.e been plottedin #igure ?3;03 $n contrast to the %- the economic gro,th(!C) rate of Nepal has ne.er reached double digits (thema*imum is 536J in ;51?)3 As discussed in section/3?38- a higher !C is e*pected to necessitate moreimports of capital and consumer goods (and ser.ices)thereby leading to a higher %3

Figure *.1+

!cono$ic Gro8#0 and Trade Balance


%"-& -&" pre-li0eralisation%&-%!() -"&

%%-!+() -*

%*-"+ - pre-li0eralisation

%"-%!() -"%%-!+() -

%"*-% -% pre-li0eralisation%%-%*() -%

%%"-!+() -%


78/109

here are limited cases (for e*ample- in ;511- ;55?- ;557-/000) ,hen an increase in !C has ,orsened the %3 "n thecontrary- gi.en the decrease in !C (for e*ample- in ;566-;510- ;51>- /00/) the % has ,orsened remarably3

$n remaining years- these t,o .ariables are changing

the direction nominally or irrespecti.e of the magnitude ofchanges in each other3 "ne can put hisUher argumentdiKerently that despite a higher %- !C has not declinedrather increased3 he graph- ho,e.er- does not indicate aclear linearrelationship bet,een !C and %/?3 4ut- in comparing the a.erage !Cand %of other SAARF/8 countries- a diKerent relationship appears3 NepalBsa.erage% (D530J) during ;567D/00> is more than double againstthe ,eighted a.erage% (D?3;J) of fi.e South Asiancountries3 "n the other hand- NepalBs a.erage !C (?3/J) of

the same period is signicantly less than the ,eighteda.erage !C (630J) of those fi.e countries3 $t has gi.enground to argue that a higher % is liely to cause a slo,er!C and .ice .ersa3 o sum up- the !C rate of the countryhas no clear le.erage to magnify its %3

#igure ?3;; e*amines the interrelationship bet,eena.erage !C rate of trading partners and 4 of Nepal3Specifically- the gure sho,s ,hether or not higher (lo,er)economic gro,th in trading partners dampen (,orsen) the% ofNepal due to increased (declined) demand fordomestic e*ports3

Figure *.11!cono$ic Gro8#0 in %aor Trading 3ar#ners and TB in Nepal


Ci.en the increasing !C of $ndia (the biggest tradingpartner) in successi.e years@ NepalBs % has been increasing,hich contradicts ,ith the theory in general (see /3?38)3Similarly- the mo.ement of !C rates in the S andCermany (second and third biggest trading partner

respecti.ely) too do not reIect a uniform response ,ith


79/109

NeplaBs %3 Regardless of the magnitude- Gapan hasdecreasing !C o.er the years ,hich is some,hatconsistent ,ith decreasing % of Nepal in the same period3

As such- there appears no .isible relationship bet,eenhighUlo, economic gro,th of trading partners andimpro.ingU,orsening % of Nepal3 he contradictionmight ha.e emerged


80/109

from the fact that NepalBs e*ports to and imports from thesecountries are too small (in their total trade) to e*hibit anyconsistent pattern3

,18 (ac# of Competitiveness and Trade Defcit

Apart from di.ersication of product and destination-competiti.eness is considered to be one of the maordeterminants of NepalBs % (see Section/3>)3 rade competiti.eness- in a narro, sense- is primarilylined ,ith a.erage cost eKecti.eness and producti.ity3Foncurrent scal- monetary and trade policies@ nancialand physical infrastructures- a.ailability and quality of ra,materials and human resources are .ital determinants ofcompetiti.eness3 Nepalis a labourDabundant country andhence its labour cost is competiti.e among the neighbouringcountries- ho,e.er- labour producti.ity is quite lo, (able

?3>)3

Table *.:nnual 3ercen#age '0ange of >abour 'os#s and >abour 3roduc#ivi# of !ig0# :sian

'oun#ries*

6ountr3 a0our 6osts a0our .roductivit3

9epal

India

!

+

++

6hina %! !

Indonesia & &

2hailand &+ !"

Sri anka !&

>ala3sia % %

.hilippines "+ !

Source: Anited 9ations Industrial Development 8r$aniHation (A9ID8), Year Book of IndustrialStatistics

2001 and International a0our 8r$aniHation (I8) Year Book of Labour Statistics 2001 in IWG (!!)

Since Nepal e*hibits the lo,est gro,th rate of ,agesdepicted in able ?3>- the unit labour cost is the lo,est

among these eight countries3 %espite the lo, labour costper ,orer- Nepalese manufacturing sector is passing

through a minimum .alueDadded per ,orer compared toother Asian countries (able

?3?)3 %espite the ad.antages of lo, unitDcost per labour-Nepal has smaller

labour producti.ity among its neighbouring (andcompetitor) countries3 his lo, producti.ity has led to a

higher unitDcost of labour in the list (column F)3


81/109

Table *.*nde" of 'os# 'o$pe#i#iveness ndica#ors of Nine :sian 'oun#ries 1999

6ountr3a0our 6ost per

Worker (#)"

/alue #dded perWorker (B)

Anit a0our 6ost (6)

!! !! !!

Source: A9ID8, Yearbook of Industrial Statistics !!! and I8, Yearbook of Labour Statistics !! inIWG (!!)

'ie,ise- NepalBs competiti.eness in regard to infrastructural costis also higher compared to its neighbouring countries (able ?38)3"n the one hand- the supply of electricity is not regular due toloadDshedding- and on the other- the tariK rate is remarably higherthan neighbouring countries3

Table *.5'o$para#ive 'os# of !lec#rici# and ?a#er @se

9epal !!% !!&+ ! to !"

India !!+ !!*+ !+ to !+

Ban$ladesh !!+ !!*& !+*

.akistan !!* - !!"+ to !%

Sri anka !!"% - !+

Source: IWG (!!)

he 'ogistics Performance $nde* ('P$)- ClobalFompetiti.eness $nde* (CF$) and Eorld Co.ernance $nde*(EC$) are belie.ed to intensi.ely measure the challengesand opportunities in the trade performances ofcountries3 Fompared to its neighbours (also competitors) andtrading partners-Nepal stands the ,eaest competitor in 'P$ and CF$,hile it is relati.ely better than $ndia but ,eaer thanothers in EC$ (able ?37)3

9epal

India ! ! &

6hina &! " "

Ban$ladesh ! ! %!

Indonesia ! "* &"

2hailand +&! %! %+

Sri anka *! % !

>ala3sia %*! %!% %

.hilippines *!! "+ %

6ountr3

eter#v$ 8verall 2ariff Industrial 2ariff


82/109

Table *.6>ogis#ic 3erfor$ance nde"4 Neig0bouring 'oun#ries and Trading 3ar#ners

9epal + * -%

Ban$ladesh +" !" -

India !" ! ! -+

.akistan * ! "*

Sri anka +! "" ! -%

6hina ! & *

1apan +! % *

AS# & -+

German3 +! " ! +%

Source: WB, 'World 2rade Indicators-!!&' and World 3 (overall

,++)

,9G' (,++-

+) in an;

?G (!ase of doing

business ,++-)

+


83/109

4 of .e (landloced and coastal) SouthAsian countrieshas been sho,n3


84/109

Table *.-

TB of Sou#0:sian >andloc;ed and 'oas#al 'oun#ries

6ate$or3

2B in C of GD. (.eriodic #vera$e)Wei$hted

()

#vera$e 2B

(%&-!!) Cof GD.

%&-% %%-!

>andloc;ed'oun#ries

(>>'s)

9epal -!

Bhutan -*

#f$hanistan na

Ban$ladesh -*

.akistan -*

Sri anka -" -&*

1+.5

'oas#al'oun#ries

6.-

Data source: WB, 'WDI-!!"' and author's calculation

#rom the table- the indi.idual % of ''Fs in ;51;D5; and;55/D0/ is higher than the coastal countries ignoring theone e*ception of Nepal and Sri 'ana (in ;51;D5;)3Moreo.er- the a.erage % of ''Fs throughout ;51;D0/ is>31 percentage points higher than the coastal countries inthe region3 +ence- the crossDcountry comparison has left aground to attribute the landlocedness as one of thesubsidiary determinants of Nepalese %- ,hich could ha.edirect implication ,ith the economies of scale andcompetiti.eness of the country3

,1@ Con>ict and Trade Defcit

%uring the period of conIict (;557D07)- there ,ereundeniably other factors at function ,hich could alsoinIuence the 4 of the country3 Specically- all the factorsdiscussed in earlier subDsections ,ere acti.e at the sametime3 +ence-the causality bet,een conflict and % is diKicult to quantify3 And- theeKect ofconflict is less liely to appear immediately3 $n obser.ing#igure >3> ,e do not see a significant change in the ongoing% in goods3 he decit slightly ,orsened in ;556 but it

impro.ed dramatically in ;551 and /0003 Actually- theconIict ,as not intensied in those initial years and thefa.ourable NepalD $ndiarade reaty signed in ;557 ,asmost liely ameliorating negati.e eKects from the conIict3$n /00;- the conIict ,as in its ape* and the % again faceda do,nturn e*acerbated by other equally stronger factors- .i3-SeptemberD;;(terrorist attac in the S) and the Royal family tragedyin /00;3 Moreo.er- the rene,ed trade treaty ,ith $ndia in/00/ ,as an impediment to the e*port ofsome ey productsof Nepal to $ndia (Mo#- /00>U0?)3 he trade in ser.ice-ho,e.er- re.eals a continuous (e*cept ;555) do,nturn after;556 until /00/ (#igure >3>)3 ourism industry- the maor

-%

-

na

-&!

-%


85/109

source of ser.ice- ,as se.erely affected by the conflict,hich could other,ise compensate some of the decit ingoods (see #igure >3?- left panel)3 he a.erage 4 in goodsand ser.ices before and during the conIict has beensummaried in able ?313


86/109

Table *.Trade Balance in Goods and Services ( of G73) in 'onflic# 3eriod

2B9ine Eears Before 6onflict

(%&"-%)

9ine Eears Durin$ 6onflict>/

%%*-!!!

(Be$innin$ phase)

!!-!+

(.eak phase)

%%*-!+


he deficit in goods during the conflict years is higher thanthe preDconIict period3 Surplus in ser.ices remarablyclimbed up e.en in the beginning of conflict3 4ut the,orsening eKect of conflict is .ery distinct in the peaphase of conflict ,here ser.ices ha.e sharply declined by63>J points3 "n a.erage- the decit in goods and ser.icesbefore and during the conflict is almost same3 Ne.ertheless-in the absence of crossDcountry comparisons andUorapplication of some econometric model the ndings mighthold a methodological bias3

Goods -+ -%" -! -"*

Services % ! *!

Good and Services -!" -! -+ -!&


87/109

Chapter *Conclusion and /olic- Recommendations

his research paper began ,ith one principal obecti.eand one research question3 $t solely aimed at ans,eringthe principal causes of % of Nepal3 ,o hypotheses ,eremade3 he rst hypothesis ,as founded on the role ofe*ternal shocs3 4oth the demand and price shocs t,o maincomponents ofe*ternal shocs ,ere analysed to the e*tent of their .isible impactsonNepalese e*ports and imports3 he second hypothesis ,as on thefoundationof internal bottlenecs@ mainly the economic- geographical andpolitical factors3

*1& Conclusion

he causes of % in Nepal begin from the e*isting structureof the foreign trade3 $t suKers from an absence of e*portdi.ersication in terms of commodities in particular- anddestinations in general3 Moreo.er- the e*ports basetcomprises mainly those commodities ,hich are priceDelastic3 $n contrast-the imports baset includes a full rangeof di.ersied products ranging from basic consumptiongoods to .arious highDtech commodities that are relati.elypriceDinelastic3

$n ;576- NepalBs % in terms of C%P ,as almost ero(03;J) per cent

but it ne.er regained that position until /00?3 Not only the% ,ith $ndia gre, larger but it also continued after late;550s3 he decit ,ith other countries (in aggregate) is alsohigh (87J on a.erage)3 Merchandise trade is found al,aysin deficit ,hile the ser.ice sector ,as in surplus rangingfrom one to thirteen per cent of C%P3 Ne.ertheless- thesurplus in ser.ice account ,as not suKicient to amelioratethe decit in merchandise3 %uring most of the study period-the income account- though .olatile- stood positi.e3 he sie

of the % of Nepalis found signicantly higher than its neighbouring and other maortradingpartners3

$n regard to .alidation of the rst hypothesis- theanalysis pro.ided a ground to attribute the e*ternal shocsas stronger causes of % in Nepal3 +o,e.er- the impacts ofthese shocs in Nepalese 4 are of diKerent magnitudes3Some stronger demand shocs that resulted from thereection of Nepalese carpets in Cermany (in ;55?D58)- theS and other !uropean countries due to the alleged childDlabour use ,ere .ery po,erful in intensifying the % in late

nineties a

Documents

Rajan Silwal ECD