Nepal: Trade and Competitiveness Study

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Abstract

This study analyzes Nepal's trade policies and performance, identifies constraints to increasing trade competitiveness, and recommends policy changes and technical assistance to improve trade performance. The study is timely, as Nepal's interim Poverty Reduction Strategy Paper of 2003 assigns a key role to trade and exports as drivers of broad-based economic growth-one of the four main pillars of its strategy. Key conclusions of this report suggest Nepal's trade policies are generally sound, and the country is competitive in a variety of products. However, these positive factors are tempered by constraints that make Nepal's productivity among the lowest in the region, create an inhospitable business climate, and discourage foreign direct investment-a key conduit for export-market access and technology transfer. The most critical constraints are: 1) delays in customs and transshipment to India's Kolkata port; 2) high infrastructure costs, especially transport and power; 3) a rigid, formal labor market; and, 4) weak policy and institutions in the areas of taxation, investment and trade promotion. But Nepal's prudent macroeconomic stance throughout most of the 1990s, helped increase its competitiveness. Low levels of domestic borrowing by the public sector, the nominal anchor of an exchange-rate peg with India, and a large jump in remittances by expatriate Nepalese labor have enabled Nepal to maintain macroeconomic stability. Notwithstanding, and despite liberalization and growth of trade in the 1990s, the study shows that competitiveness of Nepal's economy is low, as measured by firm-level surveys in manufacturing, farm yields, and aggregate productivity estimates. Labor productivity in manufacturing and agriculture are among the lowest in the region, while manufacturing unit labor costs are among the highest, even though Nepal has comparative advantage in a range of agriculture and manufacturing products. This study shows how three key factors contribute to low price competitiveness and productivity in Nepal's economy: a) inadequate mechanisms and incentives for firms to acquire new technology, b) weak infrastructure, and, c) an unfavorable business climate. Conclusions suggest major impacts of trade on the poor can come from switching to high value cash crops from subsistence agriculture. A key constraint to that is inadequate transportation infrastructure. Growth of transport can lead to welfare effects for the poor by enabling commercial crops and use more fertilizers by farmers. Transportation also has direct welcome effects through creation of employment and income-generating opportunities. To this end, transition from traditional subsistence agriculture toward higher-margin, tradable crops (such as spices, tea, and vegetables) can be promoted by increasing access to year-round irrigation, inputs, technology, and, most importantly, markets.