Nepal’s Ever Widening Trade Deficit

In many economies, trade has worked as an engine of growth but this is not the case in Nepal’s context. Nepal has been running a trade deficit since 1965 and the deficit is incurred mostly in merchandise trade and partly in income. The export policy clearly recognizes that the unfavourable balance of payments led by trade deficit is responsible for negative effects on the economy and slower industrialization. If this continues over time, it can have an adverse effect on foreign currency reserve of Nepal and thereby invite macroeconomic instability. Identification of the issues and challenges of Nepal’s widening trade deficit is crucial in the sense that Nepal can hardly incur trade deficit of significant size forever. The trade sector of Nepal suffers from an absence of export diversification in terms of commodities in particular, and destinations in general. Shrinking industrial activities is one of the disturbing features of Nepal’s economy. Nepalese industrial bases have been enfolded and squeezed over the years. Nepal’s industries failed to capitalize on the opportunities unveiled by the remittance-fueled consumption in the domestic economy, compelling the domestic economy to depend on imports to meet increased internal demand, let alone producing goods for exports. In addition, lack of exportable production from volume, value and quality has contributed to a great extent in widening the trade deficit. Also, inadequate and poor condition of trade-related and other infrastructures is limiting the prospects of industrialization in Nepal.

Following a report on the macroeconomic and financial situation of Nepal based on the first ten months of 2018/19 published by Nepal Rastra Bank, merchandise exports increased 18.1% to NPR 78.53 billion. The percentage of increase in merchandise exports during the same period in the previous year was 9%. Similarly, the merchandise imports increased 19.6 per cent to NPR 1178.14 billion in ten months of 2018/19. The increase in merchandise imports during the same period in the previous year was 21.8%. Merchandise imports are significantly higher than the exports and have been increasing for a couple of decades, hence, the widening trade deficit. The total trade deficit in the ten months of 2018/19 widened 19.7 per cent to NPR 1099.60 billion resulting in a decline of export-import ratio marginally to 6.7 per cent. The ratio was 6.8 per cent during the same period in the previous year. Merchandise trade is mostly found in deficit while the service sector in surplus, but the surplus in service sectors is not sufficient to wallop the deficit in merchandise trade. External shocks (both demand and price shocks) can be attributed as a robust contributor to the widening of trade deficit. Demand and price shocks in larger economies of the world have had ineludible impacts on the trade balance of Nepal. Also, internal bottlenecks; primarily the economic, geographical and political factors also played a significant role in directing the trade balance. Likewise, the widened trade deficit can also be imputed to a low rate of domestic savings.

Nepal’s export base is quite narrow which can be attributed to the high cost of production coupled with poor access to international markets. Despite having a strong export potential, Nepal lacks the production of commodities that can compete in the international markets. A steady decline in the overall export has a portrait of a dismal indication in the foreign trade sector. Despite many agro-based and other industries having comparative advantages, they could not come up due mainly to the absence of incentives. The collapse of a large number of the agro-based cottage and small-scale industries and over-concentration in few-imported raw material based manufactured products has constrained Nepal’s industrial diversification. The massive inflow of highly subsidized agricultural products from the southern neighbour under the open border and free trade arrangements of primary products and rising asymmetry in agricultural-related policies between the two countries have had pervasive negative impacts on the Nepali agriculture worsening the terms of trade.

It is evident that no country has grown without practising international trade. International trade earns a country foreign exchange earning which can be used to import capital goods and other consumer goods and services that are not produced in the country domestically. It is, in fact, one of the major components contributing to the GDP in many economies. On the contrary, a persistent and ever-widening trade deficit in international trade questions the health and sustainability of the economy. A compulsion to shift toward industries with competitive advantages would help tap the tremendous potentials of both agro- and forestry-based industries. However, there are more challenges and risks emanating from the given adverse initial conditions in terms of productivity and competitiveness. Imports, on the other hand, are swelling up as a result of remittance prompted consumption. Demand, however, remained strong due mainly to remittance inflow. With remittance in hand, the increase in consumption is being met by excessive imports minimizing the gross domestic savings and the gross national savings. It is not wise enough for Nepal to regard remittance as a substitute for national development and poverty reduction strategy because the need of the hour is a multidimensional approach towards attaining long term sustainable development where outmigration should be considered as just one constituent.

One of the dire needs now is the improvement in the trade structure of Nepal which is possible with diversification of exports in terms of commodities and destinations. One of the research papers on trade deficit in Nepal suggests that there should be a better assessment of consequences and impacts prior to signing off any bilateral and/or multilateral treaties on trade. Likewise, in order to make the manufacturing industries more competitive in the international market, there should be a provision of good infrastructure, skilled human resources, quality raw materials, favourable fiscal and monetary policies, efficient bureaucracy and investment in research and development. In addition, since trade in services has always been in a surplus, it can contribute to minimizing the widening deficit in merchandise trade provided that the priorities are sought accordingly.

Imports substitution and/or exports promotion would indeed lessen the country’s immoderate dependency on foreign goods. Incentivizing and subsidizing domestic industries to produce goods locally would also contribute to lowering the import volume. Also, necessary amendments to the existing trade policy prioritizing quality in terms of implementation, evaluation and effective monitoring would be conducive in minimizing trade deficit. Supply-side policies with an aim to improve the productivity and competitiveness of the economy are likely to make exports competitive and attractive, thereby increasing exports. Also, a deflationary fiscal policy involving higher tax and lower government spending would help reduce consumer’s disposable income leading to a decline in consumer spending and less spending on imports. This would also reduce inflation and improve the competitiveness of exports. But in Nepal’s context, deflationary fiscal policy may not be apt since issues of tax rivalry and redundancy might arise, hence, diversification and promotion of exports might be a nifty way to initiate with.