The Swelling Trade Deficit of Nepal

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The Swelling Trade Deficit of Nepal


The present traits of the Nepali crisis are not far from those of India in 1991. As said, history is written to make no more mistakes in the future. Additionally, a delayed response is better than no response at all. This is a time of awakening!

The journey along the trade deficit of Nepal has been a long and bumpy phenomenon. Yet there is no sign of a low tide in Nepal's trade deficit. Historical data on the ratio of the trade deficit to GDP between 1965 and 2020 shows that low tide prevailed in the former years and high tide prevailed in the latter. All-time lows were spotted in 1967 and 1968, illustrating 0.08 and 0.66%, respectively. In contrast, all-time highs of 32.82% and 33.69% were recorded in 2018 and 2019.

In comparison to other countries, Nepal's name appears on a shortlist of those with the highest ratio of trade deficit to GDP. Only two South Asian countries, Afghanistan and the Maldives, have accompanied Nepal on its descent into hell. Nepal's trade deficit in 2020 hovers at almost 30%, whereas that of Afghanistan and Maldives hovers at 29 and 42%, respectively. India has only 3%, and the rest of South Asian countries are in a much more comfortable zone.

As of yesteryear, the deficit was compensated by the ever ballooning remittance inflow; the country eventually indulged in taking antibiotics to counter the deficit. As a result of the remit, foreign currency reserves stayed in a relaxed position. The currency reserve had eked out enough from the tourism sector to maintain the reserve at a reasonable level. At this juncture, those easy days are gone. Complacency in remitting money and tourism have both proven to be costly endeavours, as both are now plagued by pandemics and other factors.

Complacency and Honeymoon
The story of complacency began with the invention of the remittance scheme in Nepal. In the years 2020 /21, almost 961 billion Nepali rupees were sent home by migrant workers. The remitted money has been inducing market demand day-by-day for both agricultural and non-agricultural goods. The demand for various services also ran a hundred-meter race. Generally, the growth of demand in an economy works as a booster for investment and industrial output, providing goods and services are produced within the country. Rather than locally producing them, Nepal opted to import them from abroad. Moreover, lust for revenue surfaced, which triggered a rapid import surge. At the outset, policy leaders were overjoyed with the windfall gains in revenues. Ironically, the fatty substance in the economy was miscalculated and misconceived.

In recent times, the honeymoon period with the import-cum-revenue-factor is melting away. After years of complacency, the economy is undergoing roller coaster rides: liquidity crunches in the banking and financial sectors; a decline in the collection of banks' deposits; and a sharp fall in foreign currency reserves, inter alia. Had a certain portion of the created demand been internally supplied, the economic success story would have been different today. This prospect is indeed a "lost opportunity" for the country and "pennies from heaven" for other countries. This is how the likelihood of trade-led growth is impeded in Nepal.

Recollection of the Indian Crisis
Does Nepal's current BoP crisis resemble that of India in 1991? To some extent, yes. The Indian economic crisis had also arisen from a BoP deficit. The deficit worsened due to excessive imports and depleted foreign currency reserves. Following the fall of the Soviet Union and the Gulf War, foreign currency reserves declined to a level that could finance imports for merely up to three weeks. At the genesis of the crisis, India too had accumulated a huge fiscal deficit accumulated since the 1980s that eventually led to a twin deficit consisting of BoP and fiscal deficits.

Referring to the Indian crisis, many answers to the current Nepali crisis are blowing in the wind. For example, India, in response, adopted an "outward strategy". The strategy included more trade openness, improving export performance, and limiting the current account deficit to a reasonable level. Likewise, the Indian strategy focused on improving non-debt capital inflows by red-carpeting FDI, controlling inflation, and boosting industrial output and GDP growth. Now, where India stands is astoundingly spectacular.

Policy Space is Limited.
Despite the country's willingness, Nepal has limited playing fields. Yes, export promotion is the first and foremost option. But the country is constrained by the small size of baskets of prospective products to sell out. Import substitution is a popular measure to overcome, but the production engines of both agricultural and industrial goods are frail enough to stand on their feet. Import management is smartly utilised elsewhere, but it has almost been the road least traveled in Nepal. Preparedness for SPS and quality-related technical measures at entry points is still far below.

The option of a devaluation of the currency seems to be infeasible for two reasons: one, the country is continuing to grapple with the exchange system pegged to the Indian Rupee. Second, devaluation may not help much since the economy carries a narrow list of goods to export. Besides, most of them are raw, having the minimum amount of added value to the economy. Had the base of exportable goods been strong and value-added, the option of devaluation would have helped exports grow. It should be noted that, except for currency devaluation, none of the four options are both quick fixes and low-hanging fruit.

The Option for Action
Aware of the issues spiraling in the Nepali economy, a Band-Aid approach may be inadequate. Monetary policies can be short-term, but other policies, such as import substitution, export promotion, and import management, can be medium-to long-term. As far as the usage of monetary tools is concerned, to some extent, the Nepal Rastra Bank has imposed new guidelines on banking and financial institutions to raise the plummeted foreign currency reserve. Injecting new rules into effect, it could have been applied earlier. As said, the sooner the better. Anyway, new rules are trying to restrict unnecessarily swelling imports.

Some, intentionally or mistakenly, argue that restrictive measures cannot be applied. However, for BoP reasons, GATT XII, XVIII:B, and Understanding on the Balance-of-Payments Provisions of the GATT 1994 allow a member country to apply countermeasures in order to overcome such odd situations. According to WTO-related legal provisions, three types of measures can be used: import surcharges, import deposit schemes, and quantitative restrictions. While applying them, one has to take into account four major self-restraints: 1) use only one measure at a time, 2) start with price-based measures, 3) have the least disruptive effect on trade, and 4) apply for a limited time until the BoP improves to a certain level. Nevertheless, these are short-term measures.

In the medium and long term, the country will have to benefit from the three measures mentioned above. For them, high priority should be accorded to capacity enhancement so that, without delay, such measures will come into effect. Here a question arises: Is the government ready to take them forward?

In a Nutshell
Only strong determination can guarantee retreat from the protracted trade deficit. To materialise it, the forthcoming budget is the nearest opportunity. But the reality is often ironic. A strategy called "Reducing the Trade Deficit 2019" was adopted by the Government of Nepal, but many of its actions never saw the light of day in implementation. This is a time of "do or die." The present traits of the Nepali crisis are not far from those of India in 1991. As said, history is written to make no more mistakes in the future. Additionally, a delayed response is better than no response at all. This is a time of awakening!  

(Mr. Ghimire is a former secretary of the Government of Nepal and is a policy researcher. You can reach him at [email protected].)

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