Cost of LDC graduationNepal may face economic consequences, including loss of international support provided to the LDCs.
Just before the second wave of Covid-19, the Government of Nepal announced that the country was all set to graduate from the least developed countries (LDC) category. The United Nations Committee on Development Policy (CDP) meeting held in February 2021 recommended Nepal’s graduation from the LDC category, which will take effect in 2026. The Committee made the decision based on Nepal’s achievement in the Human Assets Index (HAI) and Economic Vulnerability Index (EVI) index—two of the three criteria required for eligibility. However, Nepal didn’t meet the criteria of gross national product per capita income; Nepal’s average GNI per capita (2017-19) was $1,027 against the three-year average threshold of $1,222. Nepal was the only country amongst all eligible countries that decided to graduate without meeting the per capita threshold.
The decision to graduate from the LDC was taken when Nepal’s economy was hit hard by the pandemic, and those with sound knowledge of the economy knew that the country would bear the brunt of the worst pandemic of the century for years to come. Achieving the status of a developing country is one of the biggest goals of LDCs like Nepal, and it is undoubtedly a matter of pride. However, these decisions should be taken with great care, and the government should have contingency plans to ensure the country does not plummet to the same group it has leapt from.
Gain and loss
Nepal will join the club of comparatively more prosperous countries, but this does not mean it will become rich overnight. In fact, there are possible economic costs, such as losing access to the international support measures provided to the LDCs. At present, Nepal is getting almost all preferential market access under various schemes by developed countries.
Nepal’s small and medium-scale enterprises (MSMEs) will feel a major shock as they will lose the preference they enjoyed in the European Union market as an LDC. The EU is the second-largest export destination, contributing an average of 10 percent to Nepal’s export. Nepal currently benefits largely from the most generous Everything But Arms (EBA) initiative in the EU. However, Nepal will no longer get this benefit after graduation.
The EBA programme allows imports from LDCs at zero applied tariffs, whereas, after graduation, it is expected that the average applied tariff would be at least between 8 to 10 percent. Nepal will also lose preferential rules of origin facility. For instance, Nepali apparel items should be made either from domestic fabric or should have a 50 percent value addition. If it does not qualify for the much talked about Generalised Scheme of Preferences (GSP) Plus facility—which removes import duties from products from vulnerable developing countries entering the EU market—there is a high chance of Nepal losing its market in Europe.
To take advantage of GSP Plus, Nepal has to fulfil two essential criteria. First, it is available only if Nepal is considered a vulnerable exporter. Second, Nepal has to ratify and implement around 27 international conventions associated with human rights, protection of the environment and good governance. If we cannot ratify these conventions and implement them by 2026, Nepal will fall under other categories, such as Most Favoured Nations (MFN), based on the principle that countries should treat all their trading partners equally.
In regional agreements like the South Asian Free Trade Area (SAFTA), we must fulfil stringent rules of origin measures. This means we need a minimum value addition requirement of 40 percent against 30 percent. So we could lose market in South Asia, particularly on items exported under the SAFTA category. In the present context, it might look insignificant; however, it may discourage potential trade in the region.
The loss of preference and tariff costs may intensify production and unemployment. Likewise, Nepal’s export diversification will also be difficult, while there are chances of overly depending on exports to India. In the fiscal year 2021-22, the share of export to India in total export was 80 percent which came down to 70 percent last year. If we fail to assure the market in other countries, it might go up to 85 percent. Not only that, we will significantly lose exports of high-value-added products.
Additionally, development financing will bear the brunt of Nepal’s graduation. The country will no longer have access to aid for Trade, Trade Related Intellectual Property Rights and so on. Therefore, there is a need to develop a private sector-driven strategy to reduce challenges in international trade and create opportunities. Many countries have already started preparing strategies to combat the challenges of LDC graduation.
Bangladesh, which had decided to graduate from LDC at the same time as Nepal, has displayed seriousness about mitigating the challenges of LDC graduation. The country formed a committee in August 2022 under the chairmanship of the Principal Secretary of the Prime Minister's Office to prepare for the possible challenges that Bangladesh will face due to its graduation from a least-developed country to a developing country. There are seven sub-committees under this committee. Each sub-committee has members from private sector stakeholders and development researchers. Bangladesh is a champion in coping with challenges and preparing strategy and implementing it successfully. Its garment export skyrocketed after the phase out of the multi-fiber agreement of WTO in 2005.
Bangladesh is the world’s second-largest ready-made garment manufacturer and exporter. It has become one of the fastest-growing industries globally after 2005, whereas Nepal lost 90 percent of its garment export. Bangladesh’s export was around $7 billion in 2004 and has now crossed $40 billion.
Learning from others
To prevent history from repeating itself, Nepal must develop a holistic national graduation strategy that involves meaningful participation of the private sector and aims to minimise the negative consequences of its graduation from LDC. It includes searching for similar kinds of duty-free, quota-free market access. For instance, the EU provides GSP-plus as an option to the Everything But Arms (EBA) initiative, which is almost similar to the preferences under the EBA. But we need to ratify and implement 27 international conventions to get this facility. Nepal is good at ratifying conventions but has a poor record when it comes to implementation.
Nepal should also extend its preparation period for transition in the preference-giving countries. The EU provides an additional three-year transition for a graduated LDC to receive EBA benefits automatically after the effective date of graduation. Nepal should try similar facilities with other countries and lobby within the WTO mechanism to extend preferential treatment facilities for nine years.
Nepal should engage with trading partners for bilateral or regional free trade negotiations with the preference-giving countries. It should negotiate with the EU, the UK, the US, China and other potential markets for non-reciprocal market access like Indo-Nepal Trade Treaty. Capacity building of the private sector is equally important in this context. The graduation strategy’s effectiveness is impossible without a lead role of the private sector. Nepal should take this issue seriously. Otherwise, the country will pay a considerable cost for being artificially rich.