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NRC0008 – Understanding and Correcting Nepal’s Widening Trade Deficit

Understanding and Correcting Nepal’s Widening Trade Deficit Prashanta Pradhan Synopsis While trade deficit is not necessarily viewed as a problem, they tend to raise serious concerns when trade deficit persistently widens for almost two decades as in Nepal. Nepal’s trade deficit emerging from persistent growth in imports that largely cater to consumption accompanied by budget […]

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Published 23 Aug 2019

Understanding and Correcting Nepal’s Widening Trade Deficit

Prashanta Pradhan

Synopsis

While trade deficit is not necessarily viewed as a problem, they tend to raise serious concerns when trade deficit persistently widens for almost two decades as in Nepal. Nepal’s trade deficit emerging from persistent growth in imports that largely cater to consumption accompanied by budget deficit cannot be ignored. The Trade Policy 2015 specifies one of the objectives as reducing trade deficit by enhancing supply side capacity. Nepal’s Monetary Policy 2019 as well as the Budget Speech of Fiscal Year 2019/2020 underscore the need to correct the trade deficit.

Nepal’s trade deficit in numbers

International Trade Centre (ITC)’s statistics indicate that trade deficit peaked in 2018 at USD 9.5 billion which is 8 times or 725 per cent higher than in 2003 when it was USD 1.15 billion. Since then, the number has only widened. The recent macroeconomic situation report published by the Nepal Rastra Bank (central bank of Nepal) indicated that in the first eleven months of the last fiscal year from mid-July 2018 to mid-June 2019, trade deficit widened by 17.2% as compared to the previous year.

Nepal’s imports have grown consistently except for a minor slump in 2015. There has been nearly six-fold increase in imports from USD 1.8 billion in 2003 to 10.2 billion in 2018 whereas while exports have increased but only marginally at 13%. In 2003, Nepal exported USD 652 million compared to USD 732 million in 2018.

Causes of trade deficit in Nepal
  • Firstly, the surge in imports have been driven by strong domestic demand for private consumption fueled by remittances from overseas and expansionary monetary policy coupled with weak manufacturing base. The share of remittances to GDP was 28% in 2018. The current monetary policy tends to be expansionary with the limit for growth of broad money (M2) set at 18% and domestic and private sector credit growth rates projected at 24% and 21% respectively. Large pool of inward remittances and increase in money supply in the context of weak manufacturing base have led to an increase in imports of inputs and capital goods driven by construction and consumer goods to meet domestic demand for private consumption. Moreover, Nepal suffers from a weak manufacturing base. As per the World Bank, the value added of services is 50% of GDP, the share of manufacturing was only 5% and including construction was 13% of GDP which added extra demand for imports of capital as well as consumer goods.
  • Secondly, poor export competitiveness along with non-tariff barriers to trade have led to poor export development. Nepal Trade Integration Strategy (NTIS) 2016 identified 12 priority goods and services for export promotion based on criteria of export performance as well as inclusive and sustainable development. The export basket is concentrated in terms of products as well as markets. While the volume of exports has been increasing, the share of markets other than India is relatively low. Nepal enjoys preferential tariffs in major international markets through multilateral, regional and bilateral agreements to which Nepal is a party including India-Nepal Treaty of Trade, South Asian Free Trade Agreement, Generalised System of Preferences, Everything But Arms etc. Most of the export products including priority products in NTIS, face non-tariff barriers. For example, sanitary and phyto-sanitary (SPS) related barriers on agricultural products, technical barriers to trade (TBTs) in manufactured goods and regulatory requirements on services. Hence, the competitiveness of Nepalese exports is hindered leading to low volume of exports. Nepal’s export development is also hindered by higher costs of moving goods across borders. Nepal scored 77.17 in Trading Across the Border by the World Bank which is higher than the South Asian average of 62.57 but lower than Bhutan (94.25) and India (77.46).
  • Thirdly, lack of adequate financial inflows have contributed to trade deficit. Although remittances account for a major share of GDP and help fund the trade deficit, with only marginal increase in exports, remittances cannot cope up with the immense volume of rising imports. Moreover, uncertainty of inflows of remittances due to changing regional and global economic dynamics poses concerns over the volume and sustainability of trade deficit.
Impact of Trade Deficit on Foreign Exchange Reserves

Increasing trade deficit has caused loss of foreign exchange reserves. As per the available data, as of mid-June 2019, gross official foreign exchange reserves held by the central bank was USD 9.25 billion whereas a year back, it was USD 10.08 billion. On the basis of the first eleven months of imports of 2018/19, existing foreign exchange reserve is sufficient to cover merchandise imports of only 8.8 months and merchandise and services imports of 7.7 months as compared to 16.8 and 14.3 months respectively in 2015/16.

Correcting Nepal’s trade deficit
  • Export Diversification: One of the objectives of Nepal’s Trade Policy 2015 is to reduce trade deficit by enhancing supply side capacity. Export diversification shall play a major role in expanding export opportunities of Nepal and reducing trade deficit. Earlier in the week, The Kathmandu Post reported that as an effort to trim the trade deficit, the Ministry of Industry, Commerce and Supplies has identified 28 goods for export promotion which is broader than the list identified in NTIS 2016. The updated list includes medicinal and aromatic plants, black cardamom, ginger and tea, leather products, footwear, readymade garments, pashmina and hand knotted carpet under items with a high comparative advantage. The International Trade Centre’s Export Potential Map shows Nepal’s export potential markets with USD 221.9 million untapped potential with India, USD 45.5 million with China, USD 30.6 million untapped potential with the United States, USD 17.2 million with Germany, for example. Moreover, diversification and development of services sectors could be an important opportunity for Nepal to increase exports. Being a landlocked mountainous country, the geographic obstacles of trading across border shall be easier in services. On the other hand, services sector contributes directly to respective sectoral GDP and employment as well as inputs to other sectors while some services like health and education have a direct impact on sustainable development.
  • Trade Facilitation to reduce Trade Costs: Nepal ratified the World Trade Organisation’s Agreement on Trade Facilitation (TFA) in 2017. The TFA includes provisions for expediting the movement, release and clearance of goods, including goods in transit involving cooperation between authorities on customs and other areas of trade facilitation. Full implementation of TFA in Nepal could reduce trade costs by 13.9-15.8%. Nepal is implementing the Customs Reform and Modernisation Strategies and Action Plans 2017-2021 aiming to reduce compliance costs and time, helping risk management and export promotion, among others. Additionally, Nepal is also part of the South Asia Subregional Economic Cooperation programme for Customs Reform and Modernisation for Trade Facilitation Programme 2017-2021. Timely and effective implementation of trade facilitation measures shall reduce the non-tariff costs of trade and promote exports.
  • Increasing foreign inflows: Remittances have been largely offsetting trade deficits. However, remittances also bear the risk associated with global economic volatilities. Hence, Nepal should enable a favourable environment to attract more foreign investments along with remittances to ensure there are adequate inflows to finance productive activities as well as support trade balance. To the extent possible, care should be taken to ensure that such foreign investments also bring transfer of technology and knowledge while building responsible business models.
References
  1. International Trade Centre. (2019). Trade Map – International Trade Statistics.
  2. Khanal, R. (2019, August 21). Ministry moves to expand the export basket to trim trade deficit. The Kathmandu Post. Retrieved from https://kathmandupost.com/money/2019/08/21/ministry-moves-to-expand-the-export-basket-to-trim-trade-deficit
  3. Ministry of Commerce, Nepal Government. (2016). Nepal Trade Integration Strategy. Retrieved from http://www.fncci.org/uploads/publication/file/NTIS_2016_20161004020748.pdf
  4. Nepal Rastra Bank. (2016). Monetary Policy for 2016/17. Retrieved from https://www.nrb.org.np/ofg/monetary_policy/Monetary_Policy_(in_English)–2016-17_(Full_Text).pdf
  5. Nepal Rastra Bank. (2019). Current Macroeconomic and Financial Situation of Nepal. Retrieved from https://www.nrb.org.np/ofg/current_macroeconomic/CMEs%20Eleven%20Months%20English%202075-76-Final.pdf
  6. Nepal Rastra Bank. (2019). Current Macroeconomic and Financial Situation of Nepal (Based on eleven months’ data of 2018/19). Retrieved from https://www.nrb.org.np/ofg/current_macroeconomic/CMEs%20Eleven%20Months%20English%202075-76-Final.pdf
  7. Nepal Rastra Bank. (2019). Monetary Policy for 2019/2020. Retrieved from https://www.nrb.org.np/ofg/monetary_policy/Monetary_Policy_(in_English)–2019-20_(Full_Text)-new.pdf
  8. World Bank. (2019). Doing Business 2019: Nepal. Retrieved from https://www.doingbusiness.org/content/dam/doingBusiness/country/n/nepal/NPL.pdf
  9. World Bank. (2019). World Bank Data. Retrieved from https://data.worldbank.org/indicator/BX.TRF.PWKR.DT.GD.ZS
  10. World Trade Organization. (2017). TFA Factsheet. Retrieved from https://www.wto.org/english/tratop_e/tradfa_e/tfa_factsheet2017_e.pdf

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