During Dashain, I had the opportunity to see paddy fields in different parts of Chitwan while driving and cycling with my nieces and nephews. Full-stemmed paddy crops swinging with the winds are a pleasant sight. My elder brother, a farmer, told me that with the new variety of paddy, the yield of rice is now almost twice as much as ten years ago. However, in a seemingly contradictory way, Nepal has transitioned from exporting to importing rice. In fact, Nepal’s export performance is deteriorating not only in agriculture but in manufacturing as well—even though I saw several industries running well on my visit to the Balaju Industrial District.

Despite a few bright spots, Nepal’s trade performance has overall deteriorated. In fact, Nepal is the country with the largest trade deficit—an excess of imports over exports—in the world. This is because Nepal has over and over again lost its trade competitiveness.

Trade performance

An export/import orientation—the percentage of exports/imports in gross domestic product (GDP), a measure of income produced within a country in a year—can be taken as a measure of a country’s trade performance. In general, the smaller the economy, the higher the export and import orientations. Import-orientation will be higher for a small country because its production base will be narrow in the sense that it produces a relatively small set of goods and services and therefore needs to import a lot. To pay for this large volume of imports, a small country has no choice but to adopt policies to export whatever it produces at high prices, causing its export orientation to be high as well.

Nepal, which is only 0.05 percent of China and 1.0 percent of India in terms of GDP, is expected to have higher export orientation. In fact, Nepal was more export-oriented than China until 2001 and India until 2003. Since then, the neighbours’ trade performance excelled while Nepal’s tanked. Nepal’s export orientation fell from its highest level of 26 percent in 1997 to 12 percent in 2015. By comparison, in 2015, both China and India had an export orientation of 23 percent, almost double that of Nepal’s.

Our import orientation, however, increased continuously to reach 42 percent in 2015, compared to only 19 percent for China and 26 percent for India. Nepal’s trade deficit is at 30 percent of its GDP. This means, each year, Nepal’s total expenditure is 30 percent higher than its income. By comparison, China has a trade surplus of 3 percent and India has a smaller trade deficit than does Nepal.

Imports are not necessarily bad. In Nepal’s case, however, the size of the deficits and the source of financing are worrisome. They are not financed by generating income through exports or the inflow of foreign direct investment, which is more sustainable. Instead, they are financed by exporting youths as labour for remittance, which has no relation to the country’s production process. This, in turn, further erodes Nepal’s export potential.

Components of competitiveness

A fall in exports is a reflection of a fall in competitiveness. For a country to be an exporter, its companies have to be able to supply at a lower price and outcompete other suppliers. To understand why Nepal is failing to compete with foreign suppliers, we need to understand what determines the export price and why Nepal is unable to make its products cheaper than those produced by other countries.

The price of a Nepali product in foreign markets depends mainly on three things: the cost of production, the exchange rate, and trade costs.

The cost of production depends on two things: the cost of inputs used in production and the productivity of labour (how much a unit of labour can produce). The input cost includes prices of all factors used such as wages, cost of capital (interest rate, building rent), prices of intermediate inputs, and administrative costs (both legal and illegal). The lower the value of each of these components, the lower will be the price of the product and the higher will be the country’s competitiveness. Given the cost of inputs, a country becomes more competitive if its labour is more productive, which rises with a number of factors such as capital per worker, the quality of infrastructure, institutions, production technology and the degree of use of installed capacity.

The second factor that determines a country’s competitiveness is the exchange rate. An overvalued exchange rate (higher price of local currency in terms of foreign currency) makes a country less competitive by making domestic goods more expensive in the foreign market and foreign goods cheaper in the domestic market. An overvalued exchange rate is therefore akin to an import subsidy (boosting imports by making them cheaper than they should be) and an export tax (making exports more expensive than they should be).

Finally, trade costs depend on transportation costs (distance of the export market), administrative costs to prepare export documents, border clearance costs, costs to set up logistics in foreign countries, and tariffs and non-tariff barriers in the countries to which the companies want to export. The lower the trade costs of a country, the more productive its companies will be.

For Nepali companies to be able to succeed in a foreign market, their products’ price—that includes all of the components described above—should be lower than that of the domestic companies of that particular foreign country as well as that of other countries’ companies (for similar quality).

It is clear that to make a country competitive, there is a role to be played by both the companies and the government in reducing the cost of production, whereas it is mainly the government’s role to adjust the exchange rate and reduce trade costs. Nepal is failing on both fronts: neither are the companies motivated to be innovative (productive) nor is the government keen to improve the country’s business climate.

Finding a way forward

Unless policies are adjusted to make these three components—labour productivity, exchange rate and trade costs—trade friendly, no other policies will reverse Nepal’s ever-declining competitiveness. It is clear that even if all other components of competitiveness for Nepal were the same as those for China and India, Nepal’s export price will be higher because Nepal is landlocked and will incur higher transport costs. But Nepal lags behind China and India in terms of production cost as well as labour productivity. During the last quarter century, Nepal’s labour productivity fell from almost equal to one-fifth of China’s and from half to almost a quarter of India’s.

There are other policy-induced costs, too. My back-of-the envelop calculation using the data on cost of trading and four indices?—ease of doing business, cost of start-ups, corruption perceptions and global competitiveness?—shows that doing business in Nepal is 23 percent more expensive than in China and 15 percent more expensive than in India.

In conclusion, Nepal’s paddy productivity might have doubled in Chitwan but our neighbours have outpaced us. Our

industries might be running well, but similar industries are more efficiently managed in China and India. Therefore, unless Nepal consolidates efforts to revise all its trade-related policies, it is impossible for it to become a trading nation.

Acharya is an economist