“High cost of economy has hindered Nepal from coming out of the ‘Dutch Disease’ despite the end of the political transition”

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“High cost  of economy has hindered Nepal from coming out of the ‘Dutch Disease’ despite the end of the political transition”

For a long time, Nepal’s economy has remained constrained by several problems in trade and investments. The constraints have become even more visible in recent times with problems in the country’s external sector and decreasing domestic and foreign investments. Renowned economist Dr Posh Raj Pandey thinks that Nepal will have to face severe economic consequences soon if this path is not corrected. He is the chairman of South Asia Watch on Trade, Economics and Environment (SAWTEE), a regional NGO founded in 1994. In an interview with Sanjeev Sharma of New Business Age, Dr Pandey shares his views on Nepal’s problems and prospects in international trade, investment, hydropower sector development, and other pertinent issues. Excerpts:
 
The latest statistics related to Nepal’s trade, BoP, current account and forex reserve paints a bleak outlook for the country’s external sector. Are we heading for an economic crisis of some sort?
Looking at the external sector of our economy, there are two positive aspects.  First, we are in a comfortable position in terms of our stock of foreign debt which is currently at around 30 percent of GDP. Second, the inflow of remittance has not decreased so far despite the declining number of outgoing migrant workers. However, the inflow has declined in terms of GDP indicating that it has reached a saturation point. This is because the demand for Nepali migrant workers in existing job markets has saturated and new destinations haven’t been opened yet. 
 
Besides, the other parameters indicate an increasingly difficult situation for the external sector because our exports are stagnant, and imports are sky rocketing resulting in a widening of the trade deficit. So much so that it can reach 40 percent of the country’s GDP this year. Similarly, the decrease in foreign direct investments (FDIs) as well as domestic investments has also increased our exposure to economic risks. Likewise, the current account has also entered deficit territory, which used to be in surplus until two years ago, leading to the depletion of our forex reserve. Between December 2017 and December 2018, Nepal’s forex reserve depleted by USD 1.1 billion. We are headed for a situation where the country might not be able to finance its imports if there is no course correction. I think it is just a matter of time when this situation unfolds. This could happen after 18 or 24 months if this trend continues. 
 
Government officials claim that the country’s forex reserve is still in a comfortable position indicating the data of the seven months of the current fiscal year. However, it should be taken into consideration that the forex reserve used to cover around 78-79 percent of our total imports a year earlier which is now below 70 percent. 
 
The government has been planning to introduce a slew of measures including tightening merchandise goods imports to curb the swelling trade deficit. Will this measure work?
These are only immediate measures the government can take at the moment. But the right policies are required to control imports. The government needs to avoid taking the wrong steps as it did in checking the import of sugar. The government resorted to the quantitative restriction instead of going for a price-based mechanism. After the implementation of quantitative restriction, domestic consumers have been forced to pay higher prices for the purchase of sugar. Similarly, the government has also lost revenue from the sugar import. If the customs duty on sugar import had been increased from 30 percent to 50 percent instead of the quota system, it would have barred the monopoly of domestic sugar producers and increased competitiveness in the market. In the current situation, lowering the import of luxury goods is important for our economic sustainability. Nonetheless, measures like quantitative restriction, an outright ban or introduction of licensing system to import such goods needs to be avoided. Starting such practices will give discretionary powers to the government authorities which will bad for our international trade. We need to have a transparent import mechanism for which a price-based system is necessary. Controlling the inflow of foreign goods does not mean restricting every type of import. The government needs to be thoughtful enough that imports of capital and intermediate goods are not restricted. Capital goods help to increase the future productive capacity of the economy and intermediate goods are exported to international markets after the value addition by domestic producers.
 
The last few years have seen successive governments announcing their agenda of import substitution. Is import substitution a suitable approach to increase domestic production and consumption?
The government’s focus should be on increasing our productive capacity. There will be a significant inflationary pressure if the imports are checked without increasing the productive capacity of our economy. It will create a situation where only a limited number of people will benefit.
 
With the right set of policies, the government can protect the domestic market through displacement of imports. For instance, our import of agro and primary products amounted to Rs 125 billion last year. If policies are introduced and support is given to domestic producers of such goods, we can displace such imports by Rs 70-75 billion. Similarly, promoting the generation and use of hydroelectricity can also lower imports of petroleum products. In the first six months of the current fiscal year, Nepal imported petroleum products worth Rs 100 billion which is likely to reach Rs 200 billion by the end of the fiscal year. I think we can displace our total import by Rs 200-250 billion in the next 3-4 years if the government introduces proper policies and works hard for the next 3-4 years.
 
Political instability and shortage of electricity have now become things of the past. But why haven’t we been able to scale up economic productivity even though these issues are already solved now?
Policy stability is more important than political stability when it comes to increasing investments in the country. The current government has not been able to create such an environment. The Budhi Gandaki Hydropower Project is an example which shows the uncertainty in the thinking of the government which had earlier said that it would itself develop the project and collected Rs 28 billion by levying Infrastructure tax on general consumers on the purchase of petroleum fuels. Later, the project was awarded to a Chinese company. 
 
The education sector is another example of the policy inconsistency. Even though a huge amount of private sector money has already been invested, the government is now saying that all private schools will have to transform into not-for-profit organiations after seven years. It shows the government’s failure to guarantee security of investment in the country. A few months back, the finance minister had stated his personal opinion in that he believed that ‘all land in the country belongs to the state’. What message will such a statement coming from an individual like the finance minister give to domestic and foreign investors? It puts a big question mark on whether the right to own property exists in our country or not. 
 
In the meantime, years of overdependence on remittance has made Nepal a high-cost economy. The increase in remittance inflow has led to the rising demand of both tradable and non-tradable goods in the country. The soaring demand but limited supply of non-tradable goods such as education, healthcare and various types of services that cannot be imported from other countries has caused the prices of such goods to increase in the domestic market leading to the rising cost of living in the country. On the other hand, the ballooning import of tradable goods is a result of the spillover of this rising demand for such goods due to our low productive capacity. For the last many years, the Nepali economy has been trapped in the so-called ‘Dutch Disease’, a situation where the country’s focus is on limited sources (remittance in our case) but other important sectors such as manufacturing and agriculture are neglected. The high cost of the economy has hindered us from coming out of this situation despite the end of the political transition. 
 
Despite the government organizing events like the Nepal Investment Summit, why is there less attraction of foreign investors in Nepal’s export-oriented sectors?
The FDI pledges indicate that foreign investors are interested in investing here. But they get discouraged after finding out that the ground realities are quite different from their expectations. After starting the process to invest, they get surrounded by bureaucratic red-tapism, unclear policies, conflicting interpretations of a single topic matter at different ministries, several types of hassles due to the absence of one-stop service centres, problems in land acquisition, delay in getting government permission alongside procedural delays such as in environment impact assessment (EIA). It takes 18-24 months to complete the EIA of a project.
 
Besides, our education system has not been able to produce an industry-ready workforce as required by foreign businesses. It is because we emulated the clerk-producing education system of India and we still follow it. Likewise, the presence of overtly powerful trade unions is also another factor in this regard despite changes made in the country’s industrial and labour laws. Poor implementation of Nepal’s commitments in IPR is also another area of concern for foreign investors here.
 
The reviews of Nepal-India Trade Treaty conducted over the years to amend it have not produced satisfactory results. As Nepal and India are engaged in another round of talks, what should be Nepal’s agenda?
The Nepal-India Trade Treaty has created major hurdles for Nepal to displace the primary agricultural imports and to promote agro processing.  The general understanding in this context is that Nepal has been receiving preferential treatment from India in terms of exporting agricultural products to India. But Nepal has also been providing reciprocal duty-free market access to India for agricultural and primary products. So, how can Nepali farmers and producers compete with their Indian peers given that the scale of government subsidies and extension services, use of technology in farming, farm sizes and other factors in agriculture in India which are far bigger than ours? This is why people in Nepal have been leaving the agriculture sector. Until and unless the Nepal-India Trade Treaty is amended and the duty-free market access to India is removed, it is very hard for us to develop the agriculture sector and promote agro processing industries. 
 
What other provisions in the treaty should be amended?
According to the Article 3 of the treaty, if a signatory provides most favoured nation (MFN) status or concession preference to a third country, the treaty partner should be immediately given such status. This provision does not give us a policy space. For instance, if Nepal signs a preferential trading agreement (PTA) with Bangladesh, we will have to immediately provide that benefit to India as well. This means India would be the free-rider between Nepal and Bangladesh. After the customs tariffs are slashed, Bangladesh won’t be able to benefit by exporting its products to Nepal as India will take advantage of the tariff cut. I think the rules of origin mentioned in the Nepal-India Trade Treaty are also restrictive in nature. We also need to change our views towards trade. Countries now trade in tasks rather than products. Different parts of a single product are produced at various countries across the world. Creating a value chain between Nepal and India will be mutually beneficial for both neighbours. Nepal can produce, and export components labeled as “Made in India”. This way, we can also enter the global value chain. Nepal can achieve this by exporting value added products that the country imports from third countries. I think simply putting 20 percent value addition requirement would be better rather than collecting existing value added tax (VAT) of Nepal and Goods and services tax (GST) of India. It is because the taxes in both countries are restrictive in nature. It can make Nepal an attractive destination for Indian manufacturers. 
 
The problems related to excise duty exemptions for small and medium enterprises (SMEs) also need to be sorted out. As per the Nepal-India Trade Treaty, Nepali SMEs are exempted from excise duty for exporting products to India if Indian SME producers of such products also get excise duty exemption there. However, the new tax system in India has merged excise duty in GST. So, there is no excise duty in word. Nepal needs to negotiate with India to exempt its SMEs from the excise duty component included in GST. Also, there is a need to exempt Nepal from quantitative restriction placed by India on import of certain products including copper wire and zinc oxide. We need to ask India for the same quota-free market access which the southern neighbor has with other least developed South Asian countries. Meanwhile, the Nepal-India Trade Treaty needs to be made perpetual like the bilateral and multilateral trade pacts India has signed with its other countries. As of now, the treaty is required to be renewed after every seven years which has created several difficulties for us. 
 
The implementation of BBIN MVA is expected to end our problems in third country trade. What opportunities and risks do you think this framework agreement has for Nepal?
After the implementation of BBIN MVA, we can diversify our traditional port access from India’s Kolkata and Haldiya to ports in Bangladesh for third country trade. However, the modality of this framework agreement is yet to be made clear. We need to be aware about the possibility of over capacity cross-border vehicle movement on our roads. For instance, we could observe large numbers of vehicles plying on our roads if Indian transporters from neighbouring states like Bihar and Uttar Pradesh use roads via Nepal to reach the Northeast destinations of India, as going through our territory is likely to shorten their travel significantly. Similarly, we also need to avoid the possibility of dominance of Indian transporters on our roads. Our transport companies simply cannot compete with Indian transporters. 
 
At a time when increasing connectivity has become one of the major focuses of countries like China and India, do you think we’ve done adequate homework to engage with them?
We need to be clear if an undertaking like China’s BRI is a national priority for us. We also need to assess different alternatives in connectivity. What we have been doing is engaging directly with other countries without doing a cost-benefit analysis of their proposals. For instance, Nepal is a signatory to the proposed Asian Highway Network which will stretch 15,000 kms and connect 32 countries. But we have not been able to construct new roads or upgrade existing highways to meet the requirements to participate in the network. We decided hastily at the policy level to participate in such initiatives but don’t have appropriate plans to move ahead properly.  
 
Why hasn’t Nepal been able to benefit from the duty-free-quota-free (DFQF) access provided by countries like United States and China?
The trade preferences announced by the US and China are very much diplomatic statements of the two countries. China, for example, has been providing DFQF access to Nepal for exporting about 8,000 items. However, it is beyond our means to produce and export many of the goods listed for such market access. What is the use of providing DFQF access to Nepal for exporting aircraft which it does not manufactures now or will manufacture even after 10 years? Currently, Nepal has just around 150 exportable items and the government has had long negotiations with China to provide DFQF facilities for such items. Nevertheless, China provided DFQF access to Nepal to export only a handful of the 150 items. 
 
The Nepal Trade Preference Programme (NTPP) of US is also not much different. Our major items in readymade garments (RMG) have not been included in the NTPP list. Three-fourth of our exportable items have been excluded. Those included have low tariff value. Besides, non-tariff barriers like hassles in documentation and clearance processes are also behind our inability to benefit from DFQF market access. The DFQF facility providing countries have raised non-tariff barriers to such an extent that our exporters face several difficulties in exporting the items.
 
Our weak economic diplomacy and negotiation capacity have been highlighted several times over the years. What type of economic diplomacy do you think we need at present?
From trade to FDI, economic diplomacy covers a broad spectrum. The government bodies, either in or out of the country, should actively engage in economic diplomacy for better outcomes. For example, if foreign investors face procedural hurdles here, the Ministry of Foreign Affairs needs to lobby with the authorities concerned in order to address the issues. Part of our economic diplomacy should consist of promoting Nepal’s tourism, technology transfer, adapting to technologies of the fourth industrial revolution and green technologies, and the development of required skills. 
 
Hasn’t the time come to shift our focus to service exports given the subdued state of agriculture and manufacturing?
The structural change of an economy’s initial phase is marked by the dominance of the agriculture sector, middle phase by manufacturing and services in the advanced stage. We have skipped the middle phase. Nepal’s services sector now is the largest contributor to the country’s GDP as well as its exports. It is true that export of services carries huge potential for a resource-deprived country like Nepal.  But the current five percent contribution of the manufacturing sector to the country’s GDP will not be sustainable for the long run of Nepal’s economy. We need the manufacturing sector to contribute at least 12-15 percent to the GDP in order to reach levels of sustainability. It is important because any country below this level is a high-risk economy that can collapse at any moment due to internal and external shocks. 
 
There are two types of benefits from the development of the manufacturing sector. One, it generates employment. Two, industrial activities are replicable and can be easily boosted. For instance, it won’t be hard for Nepali producers to increase the production of noodles to 20,000 metric tonnes (MT) annually from 5,000 MT at present. Enhancing productivity in the services sector, meanwhile, is quite hard. For example, it takes a lot of effort and resource to establish a bank. The ratio of capital and employment is always high in manufacturing sector. By investing just Rs 100,000, two man-year employment can be generated in manufacturing which is not possible in the services sector. 
 
Nepal is hoping to export electricity in the next few years. How do you observe the developments in the hydropower sector?
The amendments made in the restrictive provisions of India’s Electricity Regulations are a positive step for us. The cross-border transmission line agreement between Nepal and Bangladesh also boosts our potential in hydroelectricity generation. Nevertheless, the government’s hydropower development policies lack clarity. It is not clear what the government is trying to achieve with its ‘Nepalko Pani, Janata ko Lgaani’ programme. How can it be helpful for hydropower development when all major profitable and low-cost hydropower projects are put into the basket of ‘Janata ko Laagani’? It raises the question of whether this programme incentivizes or disincentivizes private sector engagement in the hydropower sector. Of the total domestic production, the share of Nepali independent power producers is half and the rest is produced by theNepal Electricity Authority (NEA). Similarly, the private sector has more power projects under construction than NEA at present. Given bureaucratic red tape, the management of the hydropower projects under this campaign is also another concern. Ultimately, all these shortcomings have created a big question mark in our energy export potentials. 
 
What impact do you think will the ongoing trade war between US and China have on South Asia and Nepal’s economy?
International trade has remained the main engine for growth over the last 30-35 years. The ongoing trade war will eventually led to a decline in international trade, hence causing a global economic slowdown. This will lead to the reduction in import demand of goods. Nepal’s exports can get affected by the global situation. China, which has been producing low-cost goods for a long time, is trying to find markets for its products after US slapped the world’s second largest economy with a series of tariff hikes. India can get affected from the inflow of Chinese goods into its market. Cheap Chinese exports can overtake Indian exports in markets across South Asia. There is a possibility that the low-priced Chinese products can flood the Nepali market in a scale never seen before. Those products that we have been importing from countries such as India and Thailand now can come from China. 

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