Introduction to Nepalese Trade with Relation to China & India

Abstract

Nepal needs to reflect on the massive paradigm shift that the country has undergone in the political, social and cultural life of the people and frustrated expectations of the masses may create massive negative social upheavals if the new political set up and government could not match the expectations of the people for enhanced prosperity based on economic growth. Nepal no more talk about being ‘yam between two boulders but ‘a vibrant bridge between two neighbors’ and now attitude has changed from being ‘India-locked to India-open’. By keeping house in order, particularly having political stability and political commitment, rule of law, better investment environment, time has arrived to bring a way for a “win-win’’ for all three partners: Nepal, India and China, who can cooperate to establish transit links, communication links, and manufacturing together and it can move forward for integration using comparative advantage of each country. 

Nepal, as is in between two giant economic neighbors, has great potential for trade and investment. Nepal can mobilize its immense resources such as water and other natural resources including youth population bonanza. It also has comparative advantages for bilateral trade and investments as a transit hub between India and China. The membership with WTO has provided opportunities to Nepal for strengthening trade and investment. Similarly, Nepal’s activism in regional initiatives such as SAARC, SAFTA, and BIMSTEC has encouraged us to go for trade integration regionally and globally. Nepal needs to attract investment and boost trade by making aware the investors and business communities of our neighbors by highlighting that Nepal is liberal on foreign investment and allows 100% foreign ownership in most of the sectors of economy with attractive investment rules and procedures, relatively low tax rates, open and liberal export and import rules and procedures, low labor costs and an increasingly literate population, existence of immense source of hydropower and minerals, reforms in relevant major laws and regulation etc.

Nepal has had major investment boost recently from both neighbors. China became top foreign investor and offered more than a fourfold increase in assistance from the existing 150 million RMB to 800 million RMB for 2015/16. China has accepted and encouraged Nepal as an economic bridge between China and India and beyond to whole of South Asia. However, Nepal’s trade with both the neighbors is heavily skewed towards imports. Nepal’s exports could meet only 15 percent and 2.5 percent of the imports from India and China respectively. Maintaining complementarities is thus a big issue for sustaining Nepal’s trade with these two fast growing neighboring economies. Nepal focuses on products of comparative advantages like cement, high value agricultural commodities and non-timber forest products as Nepal’s export potentials in addition to water and tourism resources. India has been its single largest trading partner from the ancient and medieval to modern times.

There are many areas where Nepal and India could work together to enhance the trade in goods and services. Services, tourism and hydropower are some of the potential areas where Nepal needs to build its supply capacity for increasing exports. Nepalese trade is taking stock of challenges in the light of emerging economies, India and China, which are also contiguous neighbors of Nepal on ways and means to enhance trade with friendly neighboring countries and increase investment from these countries including flow of tourists.

Introduction

General Background

Nepal is one of the most liberalized countries in the South Asian region. However, growth performance has been very poor in recent years, with sluggish exports and stagnating investment. Nepal has been adopting an open and market oriented trade policy for the last two decades with expectations that such policy generates positive impacts on the resource mobilization, economic development and poverty alleviation.

The first trade policy was introduced in 1983 “Exports for development”. Following the wave of economic liberalization and Structural Adjustment Program, Nepal introduced its first Liberal Trade Policy in 1992. Trade Policy 1992 removed most of the trade barriers such as eliminating licensing for import and export, establishing industry etc. The Trade Policy, 1992 primarily covered export policy/strategy, import policy/strategy, internal export policy, and foreign exchange regulation, and internal trade policy, constitution of trade council, foreign trade policy and research institution, and establishment of Nepal Trade Promotion Organization. The Trade Policy, 1992 however, largely remained unable to address issues of international trade dynamism, affiliation with regional and multilateral trading system, expansion of bilateral free trade area, simplification of trade procedures and development of new transit system.

Considering the dynamism in the trade sector and addressing alarming trade deficit, the Government introduced new Trade Policy, 2015 where major highlights carried by new policy were;

• Policy and Institutional Coherence and linkage
• Trade-in Goods, Trade in Services and TRIPS(Trade Related Intellectual Property Rights)
• Trade-Related Infrastructure Building
• Product Development and Value Chains
• Capacity Development and Export Promotion
• Trade Facilitation
• Participation in the Global production chains and value chains
• Market Access/Promotion/Diversification
• Resource Mobilization AfT(Aid for Trade),TRTA(Trade Related Technical Assistance)

However, the poor and backward countries are not able to realize the benefits of trade liberalization due to difficulties in accessing capital, technology and market, and the unequal economic levels existing among the various countries. Nepal, as a country wedged between two big economic power houses of Asia, has immense potentials to add value to its economy by forging collaboration on transport, trade, tourism and hydropower with its neighbors. Both China and India are connected to Nepal through centuries old economic, social, cultural and religious ties traversing over the mighty Himalayas and fertile plains. Nepal not only provided transit passage of trade, business persons, monks and people of high profile between India and Tibet during the ancient and medieval period but also inspired the growth of art, architecture and culture on both sides of the borders. Before 1950, Nepal's foreign trade was virtually limited to those two neighbors.

 However, the traditional trade has gone into substantial transformation along with the development of modern transport and communication system and emergence of modern production process and supply chain. The barter system of trade between Nepal and Tibet, China has been replaced by the cash payment; unilateral duty free preferences were available to Nepalese goods in line with the Hong Kong Ministerial Declaration of WTO in 2005 but with no tangible benefits; duty preference available under bilateral treaty of trade with India have been eroding due to liberalization of trade and reduction in MFN tariffs. Thus, there is paradigm shift in economic and trade relations and new challenges are emerging as a result of globalization and technological developments. This provides impetus for having a fresh look over Nepal's traditional trade and investment relations with the two neighboring countries. Nepal’s external trade is characterized by large trade deficits and overly high dependency on trade with India.

Statement of problems

Trade policy of Nepal is facing large challenges especially because of landlocked country. Trade deficits which is hampering Nepalese market, where powerful trade economy neighbor’s India and China their goods are cheaper in Nepalese market. Researcher has tried to show basic vision of Nepalese market and its struggles and deficits of opportunities and trade development issues and barriers suffered by Nepalese trade.

Objectives of study

• To create a conducive environment for the promotion of trade and business in order to make it competitive at international level.
• To minimize trade deficit by increasing exports of value added products through linkages between imports and exports trade.
• To increase income and employment opportunities by increasing competitiveness of trade in goods and services and using it as a means of poverty alleviation.
• To clearly establish interrelationship between internal and foreign trade, and develop them as complimentary and maintain relation with neighboring countries India and China.

Literature review

History of Nepalese trade with relation India & China

The history of international trade dates back to ancient periods that started with barter system and later was replaced by the mercantilist trade in the 16th and 17th centuries. The 18th century saw the shift towards liberalism. In the 19th century and till the beginning of 20th century moved towards economic liberalization wherein customs duties were lowered, quantitative restrictions abolished, currencies were made convertible with gold and people were allowed to move freely for running trade and business activities. International trade during those years was centered to European countries and America as these countries made debut on increasing industrial outputs as a result of industrial revolution. The aftermath of First World War in 1915 changed the entire course of trade as countries started taking protective measures to reconstruct the economy from the ravages of war. This caused contraction in the international trade. Meanwhile, the global economies once again become hostage to economic depression of 1930s that led rise in import duties, imposition of quantitative restriction, import control and licensing.

 This trend continued until countries around the world embarked upon the new initiatives of shaping the global economic architecture in the aftermath of Second World War (1939-45) with the establishment of Breton Wood Institutions. Thus, there is a continuous shift in the global trading system as the journey started from GATT-1947 to the establishment of a more liberal trading system under the auspices of World Trade Organization (WTO). In the 21st century, more developing countries, particularly the G20 countries have made a strident surge toward enhancing their share in the global market. The international trade of Nepal, till 1950 was confined with the neighboring countries India and the Tibet Autonomous Region (TAR) of China, with the prevalence of barter trade with the later that continued further until the first half of the last decade. Almost all foreign trade of Nepal till 1950 was concentrated with India which ran to 90 percent during the 1950-70. 

This gradually shifted towards the third countries since 1970 till 1995 as the share of trade with India remained stagnant while the trade with rest of the world to Promoting Nepalese Trade and Investment Relations with India and China started growing at an accelerated pace with a reversal in the direction of trade. The reasons behind this includes growth of manufacturing industries in Nepal- various industries in the public and private sector were emerging to help diversification of export, GSP facilities provided by the developed countries in most of the export items of the least developed countries encouraged export of woolen carpets and handicraft and quota on garment under the Agreement on Textile and Clothing (ATC), thus made it possible to export garments and apparel from the country like Nepal. The signing of separate treaty of transit in 1978 also helped to build third country trade of Nepal as this facilitated the transit movement of goods through India. On the other side, the duty free access to Nepalese goods in the Indian market were constrained due to the stringent rules of origin criteria requiring domestic content of 90 percent in 1960 then gradually reduced to 50 percent in 1991 which was difficult to materialize due to the weak resource base of Nepal. 

This scenario was reversed again after 1996 when Nepal and India made an amendment to the Protocol-V of the treaty of trade allowing the duty free market access to the Nepalese products based on the certification provided by the designated authority of the government of Nepal. The new arrangements made in the treaty triggered the flow of investment of multinational companies into Nepal and subsequent rise in the volume of export. This trend of leap-frog growth of export continued until the bilateral treaty was amended in 2002 with the introduction of new rules of origin criteria, tariff rate quota and canalization of some products. Nepal and China maintain a very long history of bilateral relation that dates back as early as 406 AD and commemorates the visit of a Chinese monk Fa Xian to Nepal and India. The cultural and social bonds are reflected in the matrimonial relations between the royalties of Nepal and Tibet Autonomous Region (TAR) of China as the Tibetan monarch Strong-Chan Gam Po married Nepalese princess Bhrikuti in the Seventh century and the famous Nepalese architect Araniko pioneered the construction of white pagoda temple in Beijing in the 14th century. The trade relations between Nepal and TAR flourished during the Malla rulers of Nepal and continued further during the latter part of 18th century. Nepal held the strategic position of facilitating transit trade between British India and Tibet-China. 

Trans-Himalayan trade was important both for Tibet and British India during those times. Thus, many trade delegations and the visit of Buddhist monks between the two countries used to take place through the territory of Nepal. Nepal's trade relation with China is guided by a number of bilateral agreements and understandings. These are; Trade and Payment Agreement-1981, 3 Promoting Nepalese Trade and Investment Relations with India and China Agreement on Road Transportation-1994, Agreement on Trade and other Related Matters-2002, MOU on Establishment of Nepal-Tibet Trade Facilitation Committee-2009, Letter of Exchange for granting Special Preferential Tariff Treatment-2010, and Cooperation on Developing Border Infrastructures-2012. The quantum of economic cooperation and trade between Nepal and China has been increasing over the past one and half decade.

Issues in trade development

Nepal as a land-locked country is faced with the challenges of enhancing the productive capacity of the economy and competitiveness of export product and services. The geographical disadvantages combined with poor state of transport infrastructure and border delays have resulted in high cost of doing business. Facing high transit transportation and logistics cost. Given low level of investment in the agricultural and manufacturing sector and low economies of scale, Nepal virtually does not provide any competitive and comparative advantages products to trade with its neighbors.

Despite the geographical proximity, Nepal has not been able to reap benefits from the rising economic clout of its two neighbors. Both of these countries provide duty free market access to the Nepalese goods either under the bilateral trade agreements or under the unilateral tariff preferences schemes. The bordering province of Tibet Autonomous Region of China is still a small market in terms of the number of population. Mainland China is located far away and transport connectivity is the inhibiting factor for the growth of bilateral trade and investment relations. Meanwhile, highly populated states of India like Uttar Pradesh, Bihar and West Bengal are bordered with Nepal, but the export trade is restricted due to high non-tariff wall, lack of proper connectivity and regulatory barriers. The preferences available under the bilateral agreement or unilateral preferences are thus insufficient to address the growing challenges of export development in the wake of globalization and liberalization of trade and investment regimes. Non-tariff barriers are the major causes behind the low performances of Nepalese trade. Lack of test laboratories at the land customs stations, no accreditation of the Nepalese laboratories, prevalence of state taxes, informal trade has been a part in the border area and various surcharges in export items are debilitating the export trade of Nepal.

Nepalese Trade development Problems

Some important problems facing by Nepal since ages which is hampering on way of developing Nepalese trade as well as bilateral trade and relations are as follows;

• Existing Trade Agreements with the Neighboring Countries are Losing Relevance
• Non-tariff Barriers Taking Away the Benefits of Tariff Preferences
• Weak Production Base and Supply Side Constraint
• Inadequacy of Transport and Border Infrastructures
• Cost of Transport and Logistics is High
• Slow progress on harmonization of customs and border agency cooperation
• Erosion of Preferences Disproportionately Affected the Nepalese Exports
• Ineffective Institutional Mechanisms
• Dealing with Informal Trade

Briefly dealing with these suffered areas & problems also analyzing its possibilities settlements to manage proper trade structure to carry out potentials trade among the nation and its neighboring countries.

Existing Trade Agreements with the Neighboring Countries are Losing Relevance

The Trade and Payment Agreement concluded between Nepal and People's Republic of China in 1981 has become obsolete as this agreement is framed on most favored nation (MFN) basis and also provides the list of few tradable items between the two countries. This stands no more relevance in context of both countries as the members of World Trade Organization (WTO) are bound to provide MFN treatment on a reciprocal basis. The memorandum signed on 2010 and 2014 on availing duty free tariff preferences to Nepalese products is basically the extension of unilateral preferences extended by China to all least developed countries in line with the announcement made in Hong Kong Ministerial in 2005. This arrangement provides no special dispensation for Nepal beyond the similar preferences extended to all least developed countries. 

Similarly, the preferential trade agreement with India provides duty free access to all Nepalese goods in the Indian markets, except a very small negative list. The preferences available under the treaty are being eroded as the government of India has also announced duty free tariff preferences to all LDCs around the world with some products in the negative list. Preferences available to south Asian LDCs are more attractive in comparison with the provisions laid in the Nepal-India bilateral treaty. No substantial provisions are made in the treaty for addressing non-tariff and para-tariff barriers and trade facilitation issues. The preferences available under the bilateral agreement or unilateral preferences are thus insufficient to address the growing challenges of export development in the wake of globalization and liberalization of trade and investment regimes.

Non-tariff Barriers Taking Away the Benefits of Tariff Preferences

Non-tariff barriers are the major causes behind the low performances of Nepalese trade. Lack of test laboratories at the land customs stations, no accreditation of the Nepalese laboratories, prevalence of state taxes and various surcharges in export items are debilitating the export trade of Nepal. Export of agricultural products both to India and China is largely affected due to the sanitary and phyto-sanitary requirements imposed through their national legislations. Nepal-India treaty of trade in Protocol to Article II mentioned that SPS certificate issued by the competent authority of one contracting party will be accepted by the other contracting party, subject to meeting the mandatory requirement of importing country. This provides space for seeking the measures for meeting the requirement of both countries entailing to harmonization of standards, testing and certification procedures. But, these are not really translated into action. 

Nepalese Bureau of Standards and Metrology and the Chinese Administration of Quality Supervision, Inspection and Quarantine (AQSIQ) signed a memorandum in 2005 for enhancing cooperation on test and certification of the industrial products. But, this agreement has not still demonstrated any results of meaningful operation. First, there are very few industrial products exported from Nepal to China and secondly, there is no vitality in implementation. A memorandum was signed between the government of Nepal and government of China in 2012 for facilitating the export of citrus fruit from Nepal but it has not yet been implemented. There are ten laws and regulations and seven decree of AQSIQ that are relevant to China's SPS regimes. The SPS responsibilities are fragmented and distributed over five different agencies: Ministry of Health, Ministry of Agriculture, ADSIQ, State Administration for Industry and Commerce (SAIC) and State Food and Drug Administration (SFDA). Getting through these institutions and processes poses serious challenges in clearances of export.

Weak Production Base and Supply Side Constraint

Nepal as a land-locked country is faced with the challenges of enhancing the productive capacity of the economy and competitiveness of export product and services. The geographical disadvantages combined with poor state of transport infrastructure and border delays have resulted in high cost of doing business Given low level of investment in the agricultural and manufacturing sector and low economies of scale, Nepal virtually does not provide any competitive and comparative advantages products to trade with its neighbors. Rigidity of labor markets, sluggish industrial and agricultural growth, and weak production base, small economies of scale and inefficient factors of production has constrained the growth of export over the years.

Inadequacy of Transport and Border Infrastructures

Many production areas in Nepal are scattered in small townships and hamlets, and still deprived of connection with the national road network. By the end of 2013-14, Nepal has a total of 26446 km road length of which 11197 km are bituminous, 6086 km graveled and the remaining 9163 km earthen; serviceable only during the dry period. The road density is around 5.57 km per square kilometer, less even from the standards of South Asia. The rural roads constructed by the District Development Committee and Village Development Committees (53143 km) outnumbers the length of strategic road networks under the Department of Roads but those rural roads are mostly unserviceable round the year due to lack of maintenance. Lack of connectivity has discouraged production due to constraint in supplying inputs and providing market access to the agricultural, non-timber forest products and the SME products. Due to earthquake of April /May 2015 has heavy damaged boarders. Some other strategic border posts still lack proper physical facilities for operation. Congested spaces, lack of warehouses and parking facilities for containers and vehicles, insecure operation and choking traffic has caused delays, inefficiencies and high turnaround time for the vehicles and containers, increasing the cost of operation. Domestic air transport is well developed as there are almost a dozen private air carriers and 32 short takeoff and landing (STOL) airstrips in various districts. No Inland Waterways Transport is yet in operation despite the three big river systems existing in the country.

Cost of Transport and Logistics is high

Nepal as a landlocked country is facing high transit transportation and logistics cost. Enormity of documents and complex procedures followed in clearance of cargo at the seaport and hassles in transit movement combined with the inadequacy of physical infrastructures poses greater challenges in reducing the overall transaction cost. Nepal ranks 108 out of 189 countries in the Doing Business Report of the World Bank-2015 which is one position higher from the overall rank in 2014. The country has progressed in the parameters of dealing with construction permits from 126 to 91 and little improvement on the indicators of registering property (from 29 to 27) but fallen back in all other parameters. In the parameter of trading across border the performance is very much dismal as the position in 2015 has fallen back to 171st from the ranking of 169 in 2014. Cost of import of a container into Nepal has been calculated to be around USD 2650 while the cost of export per container is around USD 2545 which is higher from the average South Asian cost of USD 2117.8 and 1922.9 respectively (WBG-2015). Physical infrastructures in the northern border crossings are in a very primitive stage and needs enhancement. Narrow road over the fragile slopes frequently damages the road and bridges almost every year during the monsoon season. Lack of modern facilities equipped with the warehouses, parking space and equipment’s in handling the traded cargo is making the task of trade and logistics expensive and ineffective. Government of Nepal has not yet considered the transit transport agreement with the government of China.

Slow progress on harmonization of customs and border agency cooperation

It has been a much debated issue at the bilateral, regional and multi-lateral forums and also reflected in the WTO trade facilitation agreement. The bilateral mechanisms between Nepal and India at the commerce secretary level and customs DG level have discussed this issue at length in the past. Limited progress were achieved in terms of harmonization of working hour and work days between cross-border customs, but the documents, work processes and regulatory mechanisms still stands in different settings. Moreover, the introduction of electronic lodging of the documents for speedy clearances of cargo and reliability of data is still under discussions, reeling under slow process. Mutual recognition of inspection, test and certification of the traded products could eliminate the need of repeating the same test across the borders. Border agency collaboration is not well defined in the bilateral trade agreement and the mechanisms built in the Nepal-India treaty of trade also does not function effectively. The work processes, particularly the documents and procedures on border clearances on overland trade with china is not harmonized. However, the working hour has been made compatible for the workdays despite that weekend holidays does not comply with each other.

Erosion of Preferences Disproportionately Affected the Nepalese Exports

Nepal has been enjoying duty free market access in India for all products, except a small negative list. Nepalese export to India substantially increased during 1996 to 2002 which is mainly attributed to the arrangement made through amendment in the protocol V to the treaty of trade in 1996. The first decade of the current century witnessed paradigm shift in the pattern of global trade triggered by removal of tariff barriers by various countries. The preferences available to Nepal under the bilateral treaty has been eroded, primarily due to reduction in MFN tariff, secondly, preferential market access provided to other free trade area partners and third on account of India's Duty Free Tariff Preferences (DFTP) schemes for least developed countries (LDCs) that came into effect in August 2008. The scheme with its full operation since April 1, 2014, allows duty-free market access on about 96 percent of India's tariff lines and 2.2 percent of the lines under preferential duties. Only 1.8 percent of the tariff lines have been retained in the Exclusion List, with no duty concession. India has extended tariff advantages to South Asian LDCs well ahead of trade liberalization program under South Asian Free Trade Area (SAFTA) Sixth Trade Policy Review of India-2015, WTO, and Geneva. Accordingly, all the South Asian LDCs are entitled to get duty free access to Indian markets except the alcohol and tobacco products. This has necessarily dragged Nepal in competition with rest of South Asian LDCs in the Indian markets and also diluted the preferences available under the bilateral treaties. Given the low level of competitive capacity, Nepalese exporters are disproportionately affected from erosion of available preferences.

Ineffective Institutional Mechanisms

Nepal-India treaty of trade has constituted the bilateral consultation mechanisms at the level of commerce Secretary and Joint Secretary, called Inter-Governmental Committee (IGC) and Inter-Governmental Sub-Committee (IGSC) and is supposed to meet at least once in a six month period. The meeting of IGC and IGSC is already overdue by one and half year. Given the number of issues cropping up for various exportable and processes. The institutional arrangements made under the bilateral treaty of trade are not functioning very much effectively. The current coordination mechanism is mostly limited to central level and no effective sub-national level mechanism has been construed to discuss the trade and economic cooperation issues. Nepal and China concluded an agreement in September 2009 that established the Nepal-Tibet Trade Facilitation Committee (NTTFC). This committee was mandated to coordinate and facilitate cross-border overland trade between Nepal and Tibet, China. But, this coordination body has not yet been able to make any tangible accomplishment, following its terms of reference stated in the agreement.

Dealing with Informal trade

Dealing with Informal trade has been a part of life in the border area. Whenever, the cost of compliance for formal trade is high, people normally resort to taking the second route of informal trade that is impacting the revenue of both governments and inviting some other social problems as well. Surveillance over a long stretch of open area along the international border is a difficult task which has become more complicated due to closer and almost merging settlements across the Nepal-India border. As a result, the volume of informal trade is high and mostly unaccounted for. A survey done by ICRIER in 2000 reveals that food items mainly rice and pulses, consumer goods namely, salt and cosmetics, textile and ready-made garments are normally traded informally from India to Nepal while electronics items, beetle nuts, and consumable items are traded informally through Nepal to India. Similarly, electronic goods, toys, textile and garments are informally traded from China while the medicinal herbs and plant are traded informally from Nepal to China.

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