Preference erosionLinking trade with investment is a remedy for the problem of Nepal’s trade with India
The review meeting of the Nepal-India Trade Treaty, which was held early in Pokhara (Feb 7-8, 2019), was overshadowed by the issues of non-tariff barriers (NTBs) and the trade deficit faced by Nepal. There were three key areas of NTBs that Nepal wanted India to act on: to simplify the quarantine certification process, revise the preferential rules of origin, and eliminate the existing quantitative restriction that applies to four export items (vanaspati ghee, acrylic yarn, zinc oxide and copper) which had contributed substantially to Nepal’s export values. Nepal regarded these NTBs as major factors behind its wavering export and the unprecedented rise in the trade deficit with India. Approximately, 70 percent of Nepal’s total trade deficit was with India in 2017-18.
The value of preferential treatment In a preferential trading system akin to Nepal and India, NTBs can be used by the countries as their respective trade policy instruments because tariffs are trivial to tamper with. Since the Nepal-India trade relation is non-reciprocal—with India providing total duty-free trade to Nepal (except for three products in the negative list) while Nepal not providing the same to India (except for the primary products)—India can obviously be a potential user of these policy instruments. Hence, Nepal often has to trade off between the preferential treatment and the NTBs in trade talks.
Nepal-India trade relations are based not only on the bilateral negotiation, but also on ties with the South Asian regional trade integration and the multilateral trading system of World Trade Organization (WTO). But the bilateral framework of treaties between the two countries is enabling Nepal to have preferential market access, which goes much deeper than the provisions set under the regional free trade arrangement and the generalised system of preference (GSP) provided by industrialised countries.
Without doubt, India is the primary market for Nepal’s agriculture exports, as the former provides duty- free market access for the latter. Similarly, the preferential access for Nepal’s manufacturing products to India has contributed to the expansion of the industrial base in Nepal, particularly the sectors which had large preferential margins in India. The bilateral trade treaty reinforced this in 1996, which relaxed the preferential rules of origin for Nepali products. That resulted in an abrupt growth of the industries which flourished under the exclusive duty advantage and the increased demand for specific Nepali products, such as vanaspati ghee and acrylic yarn,
Unexpectedly, Nepal’s export to India increased from barely Rs5 billion in 1996 to a striking R28 billion in 2002 which induced India to impose quantitative restrictions and standard requirements on selected Nepali products since 2003. After that, NTBs became a matter of greater concern for Nepal and raised this issue in every succeeding trade talks.
Following that, India has, already, in principle, agreed to recognise the quarantine certificates issued by ’competent’ Nepali authorities. Thus, it is Nepal’s responsibility to set up an institution accredited by international bodies. Regarding the rules of origin, recognition of an internationally established norm can be a way out, while the problem of existing quantitative restriction can be sorted out by increasing the size of quotas mutually agreed upon. These measures can be proposed by Nepal in the next round of the trade talks. And if agreed, it will give Nepal relief from this persistent problem—as long as the new forms of NTBs emerge in the future.
But over time, the value of preferential treatment for Nepal rather than the trade barriers will likely get prominence in the bilateral trade talks. This is because Nepal will inevitably face erosion of preference margins for its export with India, as India will reduce the general tariffs applied to other countries. India will vigorously cut the existing tariffs, as it seeks active engagement in the multilateral tariff negotiations to enhance access for its exports in international markets. As Nepal currently enjoys the higher preference margins, the losses from preference erosion will be higher for it. And as it loses the advantage of preference, the export will tend to drop and further worsen the trade imbalance with India. In such circumstance, what should be Nepal’s strategy?
Since the issue of preference erosion and its impact has rarely been raised in trade talks, Nepal should push this forward. It would be essential for Nepal to link trade with investment and technology transfer to boost export. For this, the measures for direct investment from India should be devised within the framework of trade agreement. It should encourage diversification of the product lines concentrated to Indian markets and moving up the value-chain of such products.
Processing of the agriculture products and promotion of low-value added consumer goods can be the potential items in the short run. In the long run, it can target consumer durables and possibly the assembling industries to expand export beyond primary products. Direct investment or the strategic alliances with Indian investors will effectively launch marketing and distribution for sustainability of the export business. This should contribute to Nepal’s competitive advantage, employment generation and trade balance, even at the low preference margins.
The concept of relating investment with trade in Nepal-India bilateral relations partly reflects the WTO’s aid-for-trade programme, which was devised for investment aid in trade capacity building of the developing countries as compensation for the export losses caused to them due to preference erosion. The proposed idea in Nepal-India bilateral ties is not exactly in line with the aid-for-trade mechanism as it aims at the private sector investment than the official development aid. Direct investment or any kind of strategic joint ventures can help promote the manufacturing sectors to maximise the benefit of duty advantage in the existing situation and to boost export to India despite the erosion of preference margins in the future.
Shakya is an associate professor of Economics at Tribhuvan University.