‘Trade deficit has negative correlation with GDP growth'
Kathmandu, April 10
Trade deficit has negative correlation with gross domestic product (GDP) growth and strong and positive correlation with consumer price inflation.
A recent study of Nepal Rastra Bank (NRB) has said that increase in real GDP reduces the trade deficit, which may be through increase in export and substitution of import. High GDP growth means more economic activities in the country.
The central bank study says that if GDP grew by one percentage point, the trade deficit would decrease by 1.62 percentage points.
However, inflation has strong and positive correlation with trade deficit. “If the consumer price inflation rose by one percentage point, the trade deficit would jump by 2.5 percentage points,” said the study.
As Nepal's trade is concentrated with its southern neighbour, consumer price in Nepal is also affected by inflation situation in India. The country's two-thirds of total imports is from India, which are mainly consumable items, including fossil fuel and food items.
“The country has to spend more to import goods from India when the price of goods goes up there, which in turn widens Nepal's trade deficit situation,” said the study.
The study titled ‘Impact of Exchange Rate on Trade Deficit and Foreign Exchange Reserve in Nepal: An Empirical Analysis' has described the empirical relationship of exchange rate with foreign exchange reserve and trade deficit in the country.
The results show that a one percentage point depreciation of Nepali rupee results in an increase in foreign reserve by 0.82 percentage point and decline in trade deficit by 0.75 percentage point.
Moreover, price stability could reduce the trade deficit besides making it sustainable, as per the study.
The empirical result suggests that undervaluation of Nepali rupee vis-à-vis US dollar can improve trade deficit and increase foreign exchange reserves. Due to pegging with the Indian currency, Nepali rupee appreciates in line with Indian currency. “This situation could be counterproductive for improving trade deficit and increasing foreign exchange reserves for Nepal.”
