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Improving on Nepal's trade imbalance (Part I)
Nepal has a per capita income of only $383, making it one of the world's poorest and least developed landlocked countries (LLDC). The country's limited natural resources, difficult topography, poor infrastructure, a weak human capital base and a history of public intervention in the economy are some of the impediments to economic growth (Buyusa).
Economically, Nepal currently runs large trade and current account deficits, which are offset by equally large service, transfer and capital account surpluses.
Nepal can be categorized as a "small country" since it cannot affect foreign export prices. In FY 2006/2007, Nepal's exports totaled USD 939 million and imports totaled USD 2.7 billion thus running a huge trade deficit. Majority of the recorded exports constituted carpets and garments and are mostly exported to the U.S. and Germany. In FY 2006/2007, Nepal's exports to the U.S. constituted 10.4 % of Nepal's total exports. India accounts for 63% of Nepal's total trade showing the heavy dependence of Nepal's economy on India.
Exports have been growing during the 1990s and there is more potential in the future. Nepal only became a member of the WTO in 2004 and this has provided it with opportunities as well as its own challenges. The cancelling of the Multi-Fiber Agreement quotas at the end of 2004 has hurt Nepal's garment industry which had accounted for 18 percent of total exports in FY 2003/04. Exports in that sector plummeted by 40 percent in the first ten months of 2005 compared to the same period of 2004 (World Bank).
Nepal followed an import-substituting industrialization strategy in the early stages of her development (APDC, 1998). Import-substituting industrialization is the strategy of encouraging domestic industry by limiting imports of manufactured goods. By protecting import-substituting industries, countries draw resources away from actual or potential export sectors. So a country's choice to seek to substitute for imports is also a choice to discourage export growth (Trade Policy in Developing Countries, IETP). An import-substituting industrialization seems to be a good option for Nepal because it can protect its domestic industry by using tariffs and quotas to encourage the replacement of imported manufactures by domestic products.
However, there are many impediments to the strategy's application in a country like Nepal. Sophisticated manufactured goods continue to be imported into Nepal. Nepal's imports consist of a large proportion of consumer goods, all the capital goods and the bulk of all construction goods (The Rising Nepal, 2009). The strategy has not worked in terms of encouraging growth of manufacturing. Complex policies combined with infrastructural hazards and bureaucratic hassles are stumbling blocks to the growth of manufacturing sectors in Nepal.
A failure of proper application of import-substituting industrialization in Nepal can also be attributed to lack of skilled labor, entrepreneurs, managerial competence and problems of social organization such as the ongoing load-shedding. These problems may not be beyond the reach of economic policy, but they cannot be solved by trade policy (Trade Policy in Developing Countries, IETP).
If government is serious in the economic development of the country, then they need to provide the incentives and proper structure for developmental projects. When the proper tools (skilled labor, less problems of social organization) are in place to encourage entrepreneurship and proper managerial competence, the market can take over and help the domestic economy. If infrastructure projects are successful, import-substituting industrialization could be one of the strategies that Nepal could use to improve its trade balance.
Image source: World Bank
http://www.parakhi.com/blogs/2012/01/01/improving-on-nepals-trade-imbalance-part-i