Nepal's attempt to save foreign exchange by strangling imports nearly suffocated the economy in the last fiscal year, trade experts said.

Worried by rapidly receding foreign currency reserves and growing trade imbalance, the government in April 2022 banned the import of a slew of items it called luxury goods.

The embargo, which lasted till December 2022, worked only too well. It had the desired effect of squeezing the bloated trade deficit, but it also caused the economy to slow down dangerously to a near stall.

Trade experts said the ad hoc decision to slam the brakes on imports put the country into total disarray in the last fiscal year. The annual growth rate sank to a new low, and Nepal plunged into its first recession in six decades in the first two quarters.

The National Statistics Office has predicted a dismal growth rate of 1.86 percent, a far cry from the government's initial projection of a grandiose 8 percent. One of the main reasons for the slowed growth, according to the official number cruncher, is the contraction in trade activities.

Reduced trade activities led to a drastic drop in government revenue. With no money in the treasury, it could not finance its projects and programmes, particularly in the construction sector. Contractors say the government owes them Rs50 billion from the last fiscal year.

"The last fiscal year ended on July 16 with a staggering revenue shortfall," said Ritesh Kumar Shakya, joint secretary at the Finance Ministry. “Trade restrictions resulted in economic activities slowing down, and as a result, the government failed to meet its revenue collection target.”

The government had targeted to raise Rs1.40 trillion in revenue but ended up taking in only Rs1.01 trillion, falling short by a whopping Rs393 billion.

The Department of Customs said the trade deficit dropped by 15.45 percent year-on-year to Rs1.45 trillion in the last fiscal year. In the previous fiscal year 2021-22, the trade deficit amounted to Rs1.72 trillion.

Nepal’s foreign trade also shrank by 16.58 percent to Rs1.76 trillion in the last fiscal year. The statistics of the customs office show that imports fell by 16.08 percent to Rs1.61 trillion, while exports dropped by 21.44 percent to Rs157 billion.

An official at the National Statistics Office said that since Nepal is now an import-driven economy, any contraction in trade activities will hurt the economy.

“So when trade activities, particularly imports, drop, there is no reason to be happy,” said the unnamed official. “The best way to narrow the trade deficit is to produce more and export more. Strangling imports will upset the economy.”

Nepal’s imports dropped by 16.08 percent year-on-year to Rs1.61 trillion in the last fiscal year. Nepal imported goods worth Rs1 trillion from India alone, followed by China (Rs222 billion) and Indonesia (Rs41.82 billion).

Petroleum products, iron ore, crude soybean oil, coal, crude palm oil, medicaments, smartphone, urea, iron and steel, and gold were Nepal's top 10 imports in the last fiscal year.

Petroleum products topped the list with imports totalling Rs352.71 billion. The government raised Rs116.21 billion in taxes from the import of petroleum products. During the same period, Nepal’s exports plunged by 21.44 percent to Rs157.14 billion.

Carpets, refined palm oil, refined soybean oil, large cardamom, felt, juice, yarn, rolled iron and steel, textile and tea were the top 10 exports in the last fiscal year. The largest buyers of Nepali products were India with Rs106.68 billion followed by the United States (Rs19.57 billion) and Germany (Rs4.35 billion).

The International Monetary Fund said in a report that trade barriers have adverse macroeconomic implications, leading to lower government revenue and providing opportunities for rent-seeking.

Larger trade barriers are associated with persistent declines in domestic output and productivity, increasing resource misallocation, uncertainty and the cost of production for businesses. In Nepal, import restrictions also eroded an important source of government revenue, the IMF said.

“While vehicles represent a small share of imports, they yield more than one-third of customs-duty revenues. The restrictions also add to inflation and create opportunities for misreporting and rent-seeking, contributing to corruption and social distrust.”

On April 26 last year, Nepal embargoed 10 types of goods described as luxury items. With foreign currency reserves going down at an alarmingly fast pace, the government imposed import restrictions besides ordering importers to maintain a 100 percent margin amount to open a letter of credit.

The restricted items included mobile sets worth over $600 and motorcycles of over 250cc capacity. Harsher restrictions followed, and mobile sets costing more than $300 and motorcycles with a capacity of more than 150cc were banned. The ban was lifted on December 6, 2022.

“Nepal is suffering from an economic slowdown. It’s because of the import restriction,” said trade expert Rabi Shanker Sainju. “Everything became expensive after imports were restricted, and the government ordered a 100 percent margin amount to open a letter of credit.”

Sainju said that, consequently, the prices of raw materials increased sharply and hit consumption due to inflation. “The manufacturing industry slowed as a result. The slowed manufacturing and high inflation led to an increase in the unemployment rate,” he said.

“The informal economy thrived after the government imposed restrictions. Everything was available in the market despite the import restriction. The only thing was that the government lost out on revenues,” said Sainju.
The months-long import ban caused revenue flows to plunge so sharply that the government was forced to downsize the budget in the mid-term review for lack of cash.

“We should not be happy at the drop in the trade deficit because it’s not an indication of healthy trade development. Trade has been shrinking rather than expanding,” trade expert Purushottam Ojha said.

“In fact, Nepal’s export should have risen to narrow the trade deficit, import restriction is not a solution,” Ojha added.

According to a government report, taxes on the import of gasoline-powered vehicles were the key contributor to the nation’s treasury.

Imports of petrol vehicles plunged by 91.7 percent, resulting in a drop in tax collection by 92.36 percent. Imports of diesel vehicles fell by 33.65 percent, resulting in a drop in tax collection by 18.08 percent.

The import of MS billets, raw materials used in the manufacture of products like steel wire and rebar, went down by 71.8 percent, resulting in a revenue loss to the government of 69 percent.

Similarly, restrictions on alcohol imports caused imports to plunge by 71.92 percent and revenue loss of 71.61 percent.