With effect of the revised Nepal-India Trade Agreement two great expectations loom large over Nepal’s trade with India. First is overcoming the non-tariff barriers (NTBs) that restrained Nepal’s export to India, despite the privilege of duty free market access. The treaty has essentially addressed the three long-standing issues faced by the Nepalese exporters: the technical requirements and standards, quantitative restriction, and the value addition criteria for preferential rules of origin.

For that India has agreed to recognize the standard certificates, issued by the “competent” Nepalese authority in order to facilitate the sanitary and phyto-sanitary requirements for Nepalese exports to India, and to simplify administrative arrangements for implementation of quotas on products under the quantitative restrictions (acrylic yarn, copper products and zinc oxide.)

The second great expectation is reducing Nepal’s massive trade deficit with India which has more than doubled to Rs. 106 billion in the last five years. This proposition cannot, however, be uncontested mainly for two reasons. While the ratio of Nepal’s export in the total trade value with India has been shrinking continuously, the import ratio has been swelling rapidly. That created a huge gap between the two. So for several reasons, it wouldn’t be that simple for Nepal to bridge the gap so soon.

Consider first the import side. During the last five years, import from India has grown unprecedentedly to approximately four times of export. The growth has been stimulated largely by a constant rise in imports of petroleum products, coals, vehicles, chemicals, machinery and tools, which constituted almost half of the import value. That indicates no immediate restraint over import surge as long as India remains a major source of inputs and energy to Nepal. And import of these products would fundamentally depend on the growth prospect in Nepal.

The option is, thus, undoubtedly to boost up export to India by exploiting the preferences offered by the treaty. Yet the task is not without constraint either. Conspicuously, the flow of export to India looks inconsistent and irregular. Hardly ten key Nepalese products individually owned more than one billion rupee worth of export to India, and with much difficultly these items indicated regularity. For the rest of major export products their performance seemed trifling. Then a question may be raised as to what causes Nepal’s export to India be so feeble in spite of the preferential treatment.

One major cause could be that Nepal depends excessively on a few commodities whose export potentiality is determined not by the “real” comparative advantage, but crucially by the duty advantage as a result of duty free market access to India. In that respect, it is pertinent to see what actually determines the value of duty advantage. Essentially, its significance depends on the difference between the preferential tariffs applicable to Nepal and the tariffs applied to other trading partners of India (or the tariffs popularly known as the MFN rates).

But equally important is to assess the actual value of preferences to Nepal as India accelerates trade liberalization. The margins of preference to Nepal are eroding as India reduces the MFN rates following its trade reform policy, particularly after the mid-nineties. As a result the preference margins for every key export item of Nepal have eroded substantially. Whether Nepal will lose Indian market following the preference erosion will critically depend on how much of its exports currently benefits from existing preferences. The higher the current preference margin, the higher the losses from preference erosion - hence the less likely it is that the gains will outweigh the losses. Since the combined share of the major export items is approximately half of Nepal’s overall export value to India, a decrease in exports of any of these products, due to preference erosion, could have a significant impact on Nepal’s overall exports to India. Similarly, the erosion of preference could lead to a reduction in the demand for Nepal’s exports because other suppliers can now compete on more equal terms as India reduces the MFN rates. Thus the repercussion could be a severe trade imbalance for Nepal.

So there is no alternative to export promotion through product diversification to recover from trade imbalance. Nepal should desirably specialize in agriculture products to enlarge India exports for two reasons. First, Nepal has a comparative advantage in a range of agriculture products. Secondly, it enjoys relatively higher preference margins and confronts slower preference erosion in agriculture exports. Hence the specialization in farm exports assures both duty advantage and stability of preferential treatment. If so, the enhanced farm exports to India would effectively correct Nepal’s soaring trade imbalance with India, provided that the commitments made by the revised treaty are accomplished.

Shakya is Lecturer of Economics at TU — bijshakya@hotmail.com