In recent times, the state of the world economy has been a decisive factor affecting the fortunes of developing countries in general and least developed landlocked countries like Nepal in particular. The world economy has been witnessing a declining trend in growth, from 3.9 percent in 2011 to 3.1 percent in 2012 and 3 percent in 2013. The US has only just recovered from a long recession while the Euro zone as a whole is reporting a dismal growth rate of 0.2 percent. Even China’s growth has slowed.

Despite these existent challenges, India seems to be successfully navigating this period of crisis. And this despite the fact that the economic situation of India’s major trading partners, who are also major sources of India’s foreign capital inflows, continues to be under stress. Given that the economic challenges faced by India are common to all emerging economies, how India approaches the economy is worth studying.

The Indian way

When India’s Finance Minister P Chidambaram presented the 83rd budget at the Indian Parliament in February, not much was expected, as it was an interim budget. However, Chidambaram, through the budget, announced a slew of measures to boost growth, particularly of the manufacturing sector. The budget reduced excise rates on many capital and consumer goods to 10 percent from 12 percent. For the automobile sector, excise duties were reduced for small cars, scooters and commercial vehicles to 8 percent; for larger cars by 3-4 percent; and for sports utility vehicles by 6 percent. For chemical industry in particular, customs duty on non-edible grade industrial oils and their fractions, fatty acids and fatty alcohols has been pegged at 7.5 percent to encourage domestic production of soaps and oleo chemicals.

The major highlights of the interim budget of India 2014/15, inter-alia, include no change in income tax rates and a projected growth rate of 5 percent for the next year. Chidambaran has cut excise duty on all mobile phones to 6 percent while soaps, TVs and fridges are expected to be cheaper. All taxes on exports have been waived for the manufacturing sector and Rs 65,000 crore has been sectioned for fuel subsidies. Three more industrial corridors have been announced even as Chidambaran has promised to create one million new jobs. Keeping in mind the fact that India’s current account deficit can only be addressed by foreign investment, the foreign direct investment policy has been liberalised to attract larger investment, rejecting the argument of policy paralysis.

Thus, the Indian government seems dedicated to keeping the Indian economy in robust health. India’s ten tasks, as envisioned in the interim budget and as part of the road map ahead, include: fiscal consolidation; addressing the current account deficit; price stability; financial sector reforms; massive investments in infrastructure; promoting the manufacturing sector as the base of India’s development; subsidies; urbanisation; skill development; and the inclusion of states as major partners in development.

All of these measures, though interim, are aimed at stimulating consumption and hence, leading to the growth of the manufacturing sector. They will also have direct impacts on Nepal and Nepali chemical industries, including soaps.

Trade imbalance

Some in Nepal opine that there is a large possibility of Nepal facing a huge trade deficit as an impact of the Indian budget. The logic goes that if India agricultural production increases, its increasing exports, which will have a resultant effect on Nepal’s production and the export performance of these commodities. Since India’s export will gain momentum, this will have a consequent effect on Nepal’s export to India vis-à-vis third countries.

It is also anticipated that there will be an improvement in Indian agriculture and an increase in agricultural exports. The budget includes a provision of exempting all duties and taxes on exports, protection for domestic industries and relaxation in excise for some products. These will all lead to an increase in the presence of those products in Nepal. In this case, it will be difficult for Nepal’s economy to remain competitive. Nepal’s export will be limited, leading to a further widening trade gap. In order to urgently address these issues, changes and adjustments in tariff rates and their regimes must be made.

Currency peg

The impact of the Indian budget will definitely be experienced by various sectors, though the reason for the impact may not be the same. In some cases, Nepal’s policymakers have opted to follow developments in India. The Nepali rupee, for example, is pegged to Indian currency; the exchange rate with other currencies is based and/or fixed by taking into account the exchange rate of Indian currency. According to the International Monetary Fund, the fixed peg to the Indian rupee has served Nepal well as it has transmitted positive impulses (growth/financial stability) from India. It has also stabilised expectations and enhanced transparency while avoiding the repercussions of political instability on exchange rate behaviour. Given these factors, there is little possibility of change in Nepal’s exchange rate system.

Similarly, Nepal’s inflation rate is determined by prices prevailing in India, adjusted for the exchange rate. Though this is not applicable for all commodities all of the time, the average price over a period of time between the two countries does not significantly diverge. These three areas—economic growth rate, prices and the exchange rate—will all be highly influenced by the policies and programmes of the Indian budget.

In the past, the Nepal Rastra Bank (NRB) used to conduct studies on the impact of the Indian budget on Nepal. Similar studies should now be conducted in cooperation and consultation with the private sector and relevant stakeholders. The suggestions, conclusions and the measures to be taken that result from the studies can be of crucial importance. Since Nepal’s economy is not faring well, the new government might have to take hard decisions.

However, all is not negative. Economic reforms in India have had a direct and positive relationship in Nepal’s economic development. India’s rising growth rate has increased investment in Nepal and even led to an increase in the demand for Nepali goods and services on Indian soil. But due to various factors, which include a lack of development in rural areas and the abolition of subsidies in Nepal’s agriculture sector, coupled with a lack of credit facilities and irrigation, Nepal has not been able to take advantage of Indian growth and development. Now, it looks as if the new Indian interim budget will further affect Nepal’s economic growth and export.

Singh is a former general manager of the Nepal Stock Exchange (NEPSE) and holds an MBA from Delhi School of Economics