India has always been the most important trade and investment partner of Nepal. India alone accounts for almost 60 percent of Nepal’s total export; import from the Southern neighbour is equally high. Likewise, Indian investment commitments to Nepal surpass those of the others.

Only with India

Nepal’s foreign trade is largely concentrated in India with which it has a bilateral preferential trade agreement since 1950. The two nations share a long open border and Nepal has pegged its currency to the Indian rupee, whose value has not changed since 1993. Despite the favourable bilateral trade treaty, which trumps any other bilateral, regional or multilateral treaty in terms of concessions and scope of cooperation, Nepal has not been able to boost exports to India. Instead, its imports are increasing at an alarming rate, which is putting pressures on the real exchange rate (nominal exchange rate adjusted for inflation in both countries).

Recent hydropower deals with Indian companies and the signing of the power trade agreement have nonetheless renewed hopes of higher economic growth in Nepal and the possibility of lowering the trade deficit with India. This may eventually be true, but another equally important issue that needs to be sorted out through constant dialogue is the one concerning non-tariff barriers (NTBs) that have been hindering exports to India.

Three hurdles

Let us first start with Nepal’s basic trade scenario and the evolving nature of trade flows with India.

Trade with India is governed by the Trade and Transit Treaty 2009, which is periodically updated through mutual negotiation. While this treaty offers nonreciprocal zero tariff on export of manufactured goods to India, both sides impose tariff on agriculture goods. Hence, the export of manufactured goods is virtually tariff less (except for export of four goods). One might wonder as to why Nepali export to India is trailing well behind imports from India despite such a generous provision. Well, the gains from slashing tariff which improves price competitiveness of Nepali exports are partially negated by the non-tariff barriers, real exchange rate appreciation, and domestic binding constraints. The combined effects of these three factors make Nepali exports to India uncompetitive, resulting in the rise of trade deficit.

First, non-tariff barriers imposed by India and also by some of its individual states are either creating an added layer of paper work or increasing the cost of exports. Of late, non-tarrif barriers Nepali exporters to the Indian market face are: stringent quarantine/food safety-related barriers, higher rules of origin standard than maintained in the 1996 Indo-Nepal trade treaty, technical barriers to trade, transport hassle at border checkpoints, domestic support to agriculture sector, and countervailing duty imposed by some states. Food-safety related barriers are imposed on almost all processed and unprocessed agricultural or forest products export to India. At times, these measures are applied on an arbitrary basis and the Indian customs do not accept the test reports issued by Nepali labs. So exporters have been repeatedly requesting the government to establish harmonised test labs in Nepal with Indian support.

Similarly, the onerous rules of origin provision and its verification further make it difficult for exporters to utilise preferential access to the Indian market. Export consignments from Nepal are not allowed to be delivered throughout India as they have to be offloaded and onloaded into Indian carriers from the nearest border town. Indian consignments, on the other hand, can be freely delivered throughout Nepal after getting one initial entry permit. Indian domestic subsidy provided to agricultural, textile and clothing production further means that Nepali non-subsidised identical production export to India cannot compete in terms of wholesale or retail prices.

Concerted efforts

Para-tariff barriers such as occasional countervailing duty on certain export items, education cess and special additional duty are a nuisance to Nepali exporters as these tend to delay delivery and also increase costs. These barriers need to be resolved through robust and regular inter-governmental meetings between Nepal and India. Encouragingly, these issues are being taken up regularly by concerned government officials and some have also been resolved. Second, the appreciating real exchange rate despite the pegged nominal exchange rate has made Nepali goods relatively uncompetitive in the Indian market. When trade deficit is increasing at the alarming rate, this is not helpful. It can be attributed mainly to the persistently higher rate of inflation in Nepal in comparison to the levels prevalent in India. It is also creating pressures on monetary authorities to pump in more dollars to purchase Indian rupees to finance burgeoning imports. The solution to this is to ensure that inflation in Nepal stays lower which is affected more by non-monetary measures than standard monetary ones.

Third, domestic supply-side constraints have crippled production and competitiveness. The major factors that have increased the cost of production are the lack of electricity, wide gap between wage and labour productivity growth, lack of qualified human resources and lack of productivity-augmenting infrastructure, such as good-quality road networks and information and telecommunication facilities. A concerted domestic effort and greater political buy-in of seemingly harsh reforms are needed to tackle these crippling supply-side constraints.

Overall, despite the lowering of tariff barriers on Nepali exports to India, non-tariff barriers are restraining export growth. High inflation in Nepal is also making export relatively uncompetitive. Finally, persistent domestic supply-side constraints continue to cripple production and raise cost of production. The combination of all these three factors is hurting export to India, resulting in an ever-widening trade deficit.

Shakya holds an MA in Economics from Tribhuvan University