Increasing Production Key to Reducing Trade Deficit

  12 min 22 sec to read
Increasing Production Key to Reducing Trade Deficit

Naindra Prasad Upadhaya is a former commerce secretary during when one of his major contributions was to give continuity to TIFA Council Meeting with USA and achieve preferential market access in US for Nepali products in 77 harmonized tariff lines. He also served as Consul General at Lhasa. Madan Lamsal, the Editor-in-Chief of New Business Age, talked to Upadhaya on a wide range of issues related to Nepal’s trade and commerce sectors, focusing on the country’s foreign trade. Excerpts:

How do you view Nepal’s foreign trade at present?
If we look at our foreign trade by analysing the data, we see it is becoming challenging every year.  Our foreign trade is highly imbalanced. If we look at data of the first 10 months of the current fiscal year released recently by the Nepal Rastra Bank, we see imports have escalated compared to the same period of the previous fiscal year. Imports have already crossed Rs 1,400 billion, compared to around Rs 1,100 billion in the last fiscal year.  During the period, we could export goods and services of only around Rs 173 billion. Imports have outnumbered exports by a mile. We are seeing a huge and persistent trade deficit. The situation is becoming alarming for us. Looking at the import trends, our total import bill will cross Rs 1,900 billion in the current fiscal year. It will put stress on our foreign currency reserves.

You said the situation is becoming alarming. What do you think that led us to this situation?
Multiple factors determine the financial health of the country. The most significant of them is the international trade deficit. Export promotion and import substitution are the appropriate measures that need to be taken to bring down the trade deficit. For import substitution, we need to expand the base of domestic production. But our manufacturing and production base is very weak. Small and medium enterprises (SMEs) have been failing to integrate themselves into the international supply chain. Those that had managed to integrate somehow are in a position to delink now due to various factors. The trade deficit started widening due to capacity constraints of domestic industries. Our domestic demand is rising exponentially, but our production capacity is constrained.  

If we are to reduce the trade deficit, we need to focus on production with investment in the real sector. Productions cannot increase if we do not spend in the productive sector. Without increasing production, we can neither increase our exports nor meet the domestic demand. We will have no option but to increase imports to meet domestic demand. It will affect our balance of payment (BoP). In fact, it already has. Last year, we were in a BoP surplus situation. But now we are at a deficit of Rs 300 billion.

Along with increasing production, we also need to take care of several issues to facilitate exports in the international market.

You say we need to increase production. But we lack manpower, the contribution of the agricultural sector is declining, we are producing what we need but exporting at a cheaper rate only to import again at higher rates. Exports incentive programs are not becoming effective. What went wrong?
Talking about increasing production, we need to identify and prioritize products in which we have a comparative advantage in the international market. There are certain sectors that hold great potential. One of them is green clean energy - hydropower, wind energy and other renewable energy. It is one of the sectors which can make a significant contribution to our economy. The second is tourism, and the third is the production of high-value crops. We need to focus on these three areas. Likewise, we also need to give continuity to subsistence farming to lower the import of food grains.

You said our agricultural products are not becoming comparative. It is true. There are some structural problems behind this. One is the delay in fixation of minimum support price (MSP) which forces farmers to sell produce at cheaper rates. Second is, we lack warehousing facilities. Farmers cannot store products in the flush season where they are offered lower prices. As many farmers have no storage facility, they are forced to sell to middlemen from the farm itself. Third is, our cost of production is high. Our products cannot compete with farm products of other countries which provide different subsidies to farmers. We need to provide similar facilities to our farmers so that our farm products become comparative.

How can a small country like Nepal compete in subsidies with a big country like India with which it shares an open border?
There are some provisions in our bilateral trade agreements. India has provided us preferential access to its market. There are quota restrictions on four products. Except for a few sensitive products, most of our products get preferential market access in India. In the trade agreement signed in 2009, the two countries decided to  provide zero-tariff access to a few products in both countries. This provision has made it difficult for our products to compete with Indian products. But we can review the provision and make amendments if needed. Because there is no other alternative to increasing production. The service sector is a different issue altogether. If we are to trade in goods, we need to increase production. Production should be raised at least to meet domestic demand. We need to increase the production of goods having the export potential to boost our foreign exchange reserve. That is why the government should work to address all constraints to increasing production.

Why the cash incentive scheme for export promotion not so effective?
When I was at the commerce ministry, we had introduced a concept of providing cash incentives to exporters. Our expectation was that it would encourage them to increase exports and in turn set a foundation for productive industries, create jobs, and support our economy. Every other country was doing the same. Unfortunately, the incentive scheme became full of hassles due to some structural problems. Exporters complained that the process of claiming cash incentive was too complex and complicated. There was a situation where companies making the most value addition and expanding our export basket - to whom the scheme was targeted - were getting few facilities. Those adding little value addition and middlemen who imported and exported products, like lentils, immediately benefited the most. Exporters of handicraft, hand knotted carpet, pashmina etc faced troubles.

We had formed a technical team to calculate value additions. The team would sometimes ask for original documents which exporters understood as hassles.  Realising this, we later changed the working procedure to end such hassles. In this year’s budget, the government has proposed an 8% cash incentive. The government has announced to provide export incentives to products like clinker, cement and footwear among others. There may be some more products. If this scheme is implemented effectively, it will encourage the real exporters, support the Nepali economy, add value addition, and help expand the international market for Nepali products. But there is a risk of the scheme falling prey to structural problems.

You talked about green clean energy. Ethanol was identified as a potential product in the past. What is the potential now?
The potential still exists. We need to start producing it without any ifs and buts.  We need to substitute petroleum imports which is putting a stress on our foreign exchange reserve. Second, our expenses on motor vehicles, machinery parts and maintenance are increasing. There may not be alternatives to motor vehicles. But it is unfortunate that we are supplying water in diesel powered tankers despite being a country rich in water resources. We need to bring fuel as well as parts for these tankers. We can bring down these costs by using clean energy at least in these motor vehicles initially.

What do you think that we can enhance our export capacity in the present context?
The first and foremost thing is increasing production. Export promotion won’t mean anything if we are not producing enough. We can see exports increasing every year. It has reached around Rs 173 billion from Rs 70-80 billion of the past.  Our import-export ratio once was 15:1. It is coming down. But our imports are increasing at an alarming rate. So, I think the focus should be on production if we are to promote exports.  We should prioritise products in which we have a comparative advantage.

What could be those sectors?
Handicraft products, hand-knotted carpet, pashmina and readymade garments are our traditional exports. Few more sectors have emerged lately. The first is green energy and the second is tourism. We are ranked 110th in the world in terms of the contribution of tourism to gross domestic product (GDP). This means tourism is an under-utilised sector for us. The third is the agriculture sector. High-value crops and medicinal and non-timber forest products have comparative advantages. These products have huge export potential. If we promote them through the National Trade Integration Strategy, we can increase exports and improve domestic consumption as well. I would like to share an example. A single importer from Japan placed orders for all our domestic productions. But we didn’t have the capacity to meet even that order. This shows the sorry state of domestic production.

Many Nepali products have comparative advantages in India. But there are many non-tariff barriers. India is stopping the import of even the products allowed by the bilateral trade agreement. What can be done to remove such non-tariff barriers?
As we have adopted an open market economy, we should move ahead with a belief that the market itself will determine everything. A consumer anywhere in the world has the right to consume products produced anywhere in the world. Instead of telling consumers to use this good, not that one, we need to focus on products that have potential.

Questions on the quality of products are raised most of the time. To do away with this, we need to set up laboratories that meet the requirements of the market.  We also need to forge an understanding with India so that it accepts our quality certification.

But many countries, including India, do not accept quality certification of our laboratories. How can we address this problem?
It is natural for importing countries to prescribe certain criteria for imported products. We also have to do the same. In fact, we are already doing it. But pirated and substandard products are still finding their way into the market because of the failure of our regulatory mechanisms. If an importing country is setting certain criteria, we should meet them by establishing internationally-accredited labs, doing packaging and labelling accordingly, and exporting products based on the quality certification issued by such labs.

Then why aren’t we setting up such a lab?
We do have such labs. The Department of Food Technology and the Nepal Bureau of Standards and Metrology both have quality testing labs. These labs were set up with the technical assistance of our neighbouring countries. Unfortunately, the same countries are not accepting quality certifications issued by these labs. They are free to not accept our quality certifications. But questions can be raised on their intent.

Even though Nepali products are finding a market in foreign countries, they are failing to do business there for long. Is it because of the weakness of our economic diplomacy?
Our missions can definitely help in promotion of our products and services in the destinations they are located. Rather than concluding that our market was lost because of the weakness of our missions, I think the dynamics of this international trade are now very technical. Specific country's problems, and even a small problem in international shipping and supply chain can make a huge impact.

One should have all the information and knowledge about international trade, ability to deal with problems should they come up as well as innovative ways of marketing to excel in international trade. If our missions are capable of doing things this way, it can definitely help.

As per existing laws, the commerce ministry handles all the issues related to foreign trade. In foreign land where it is not present, it works in coordination with the ministry of foreign affairs. There is an economic diplomacy division at the foreign affairs ministry to look after this issue. Whatever programs we carry out must be purposeful.

When it comes to trade with China, the market is flooded with Chinese goods. But we have been facing problems in exports due to the tightening of border. Why does this happen?
Chinese goods do not come from Tatopani border only. Chinese consignments are coming from Kolkata and Visakhapatnam ports as well. The government should make needful efforts to make the border points operational. I had taken initiatives to open the border points repeatedly when there were problems at the border during my tenure. The Chinese government has built a dry port near Tatopani border. It should be made operational.

What do you think is the reason behind this situation?
For this, representatives of the two sides should sit down and discuss.

The government has made an announcement to double exports, reduce imports by at least 20% and achieve a trade balance within the next five years. Is it possible?
That looks like an ambitious goal. The trade deficit was widening when we were formulating the 14th periodic plan. The import-export ratio was 10:1 at that time, and the National Planning Commission was working to bring it down to 7:1. But looking at the trend, it seemed that the ratio would climb to 13 or 14:1. We need meticulous planning to reduce the deficit. Setting ambitious targets alone won’t work.

There is nothing in setting targets though. But we need to think whether it is pragmatic. Looking at our indicators, it is near to impossible to achieve a trade balance in four-five years. By raising production, strengthening our economy and improving the supply chain, we can take the industry to the correct direction. But the targets cannot be achieved.

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