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Improved Trade Policies Can Expand Exports and Drive Growth in Nepal

Gonzalo Varela's picture
Pashminas – scarves and shawls in bright colors made from the wool of Himalayan goats – are one of Nepal’s most well-known exports. In 2016, the country exported over $25 million worth of these products, comprising 3.6% of the country’s total exports. Although the products are popular on international markets, exporters face many challenges in getting their products to customers.

One such issue is tariffs on imported intermediate goods, the ingredients to finished products. In the case of the pashmina producers, imports of the wool and silk needed to create the finished scarves and shawls face a 5% tariff. This cuts into the competitiveness of Nepalese exporters.
A woman purchases clothes from a store in Lalitpur, Nepal.
Photo Credit: Peter Kapuscinski / World Bank
Pashmina producers aren’t alone. According to a new World Bank Group report, more than 90% of Nepalese exporters directly import some of the components of their finished goods from other countries. For example, footwear exporters import more than 20 types of raw materials, including leather, glue, soles, and accessories from China, India, and Thailand. Hand-woven carpet manufacturers source most of their wool, silk and dyes from New Zealand, China and Switzerland. Nepalese tea producers obtain their filter bags from Germany, which are taxed at 36% when customs duties, VAT and all other taxes are added up.
 
For developing countries, imported intermediate goods are typically of a higher quality than what can be attained locally. They enhance the quality of finished products and using them can improve the competitiveness of exporters. And more importantly, because today’s global production is structured around international production networks, accessing inputs from around the globe is crucial to serve clients at competitive prices. Compared to other developing countries that are better integrated into global value chains, many Nepalese businesses – which are generally small and sensitive to high production costs -  are being gouged on import taxes.
 
For instance, in 2015, Nepal had a simple average tariff of 10.2% on imported intermediate goods. This was 6.3 percent higher than Vietnam’s and 6.9 percent higher than Malaysia’s. Likewise, Nepal’s average tariff on imported capital goods – a segment in which there are no domestic producers to protect - was 7.8 percent in 2015, which is more than double that of Vietnam and Malaysia.
 
According to the report Trade Policy Reforms for the Twenty First Century: The Case of Nepal, the issue of tariffs on imports is indicative of wider troubles Nepal faces on trade. These include restrictive regulations around services trade and the operation of multinational companies that result in a lack of participation in global value chains. Nepal needs to make serious changes to its trade policies in order to drive growth and achieve its goal of becoming a middle-income country by 2020.
 
Specifically, the report expands on three policy areas that Nepal could change to improve its competitiveness in global markets:
  • Simplify the tariff code, which currently works against exporters;
  • Tap into unrealized trade potential by helping firms scale up their shipments and export new products, comply with international standards, and keep better records related to the origin of products;
  • Increase participation in regional and global value chains, by leveraging regional integration as a stepping stone for succeeding in global markets;
For a small economy, trade and investment is crucial for Nepal’s growth, and currently it seems to be missing the boat by failing to integrate with its region or with the world. Globally, the average number of agreements in which countries participate is 14. But Nepal is only party to one – the South Asian Free Trade Agreement (SAFTA). This agreement is among the shallowest in the world, only covers four provisions, and faces severe implementation challenges. According to the new report, SAFTA has had zero positive impact on Nepal’s exports.
 
The progress of the regional integration agenda, and in particular the full implementation of SAFTA is crucial for Nepalese firms to scale up their exports. For Nepalese medicinal and aromatic plant cooperatives, for example, India represents two thirds of their exports. The opportunity to add value depends on being part in regional production networks or collaborating with Indian firms. For leather and clothing producers exporting from Nepal, on the other hand, competitive transportation costs to reach clients in Bangladesh make the difference between being price-competitive or being displaced by other competitors with more efficient transport and logistics systems. Better integrating with the regional economy would help businesses on all fronts.

The report argues that if Nepal can make these adjustments, not only will the country’s export competitiveness improve, but also people of all income brackets – especially the poor - will benefit. Research shows that households could see their income rise by 1.7% thanks to lower prices for both tradable and non-tradable goods. Poorer households stand to benefit more.
 
Overall, Nepal faces many challenges in global trade, but with targeted policy changes, it can reach its untapped potential.
 
Download Trade Policy Reforms for the Twenty First Century: The Case of Nepal >> 
 

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