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Nepal’s trade with India Preferential treatment overview

The Himalayan, Nepal

Nepal’s trade with India Preferential treatment overview

By Bijendra Man Shakya

4 October 2009

The Nepal-India Trade Treaty of 1996 came into limelight in the wake of the periodical review of the treaty recently. The treaty marked a milestone in Nepal-India trade ties leading virtually to free trade between the two countries. Nepal has several reasons to applaud this accord, the most important being the treaty relaxing the preferential rules of origin for Nepalese products exported to India. Since then the stringent material content requirement to Nepalese goods was substituted by the provisions of a certificate of origin for the duty preference in India. For a few products, not applicable to such treatment in India, a negative list was introduced.

The immediate consequence of the 1996 trade agreement was, thus, the growth of Nepal’s industrial sector, producing goods with a modest value addition largely concentrated to Indian markets. That resulted in a speedy growth of Nepal’s export to India and a steady cut in its trade deficit ratio, which had been on an increasing trend. But, Nepal could not benefit much with the improved trade balance as the export to India could not grow proportionately to keep the pace. The reasons behind this could be revision of product origin

rules (determining the minimum value addition for Nepalese products to qualify for the Indian preference) and imposition of tariff quotas (on selected Nepalese products) since 2003.

The market access barriers were, as usual, embraced by the latest bilateral trade agreement, but the value of the preferential market access and the preference utilization for Nepal have often been raised. It took a great deal of time and efforts to relax the rules of origin for Nepal to maximize the preference utilization. However, the process of simplifying the rules of origin took place only as India reduced the MFN (most favoured nation) tariff rates that apply to its other trading partners.

The latest trend in India’s tariff reform demonstrates that the further reduction of MFN rates is inevitable. There are two main reasons for India’s vigorous involvement in cutting the existing rates. First, it seeks active engagement in the multilateral tariff reduction negotiations, under the World Trade Organization (WTO), to enhance access for India’s exports in international markets and second, for them to serve as “bulwark” against regionalism to reduce the risk of the South Asian Free Trade Agreement (SAFTA) or other regional agreements causing trade diversion rather than trade creation. These are evidently revealed in India’s initiation towards trade liberalization, rapidly reducing average and high tariffs, including removing the licensing system, primarily between the second half of the nineties and the mid-2000. During that period, not only have basic duty rates been abolished, but also the rates have been made more uniform within the sectors. While the maximum tariff has been slashed by almost half, the simple average MFN applied rate has already been reduced by more than 60% in the case of agriculture products and 80% for industrial goods. Compared to agriculture products the tariffs have been significantly reduced for non-agricultural products.

If this is any indication, Nepal is certain to lose the preference margins it enjoyed with India more rapidly as the Indian preferential tariff for almost every Nepalese product is already zero. Between 1995/96 and 2005/06, the average Indian tariff rates for selected products, which secured a prominent place in Nepal’s export to India, has been reduced by 40% to 70%, indicating, ceteris parius, the same ratio of preference margins loss for Nepalese exports. That tends to erode Nepal’s competitive edge, ultimately affecting its exports to India unless it improves the supply capacity or it enjoys some of the increase in India’s overall exports following its trade reform and the economic growth stimulus.

Following that there are two major policy implications for Nepal. One is to materialize simplification of the stringent compliance rules and eliminate NTBs to maximize the effectiveness of the existing trade preferences, so that it can enhance product coverage and product diversification. The Indian preferential treatment is still valid for Nepal as it enjoys higher preference margins. Remember that the Indian average tariff rates are still relatively

high and the preferential rates for Nepal are already zero, creating a substantial margin of preferences for Nepal. The Nepalese experience shows that preferential treatment has supported the rapid growth of manufacturing industries in Nepal, particularly aimed at the Indian market.

Secondly, there is a need to improve trade capacity, without any delay, to diversify into more dynamic sectors concentrated to Indian markets. This is important to help Nepal raise a competitive edge, contributing not only to the industrial development but also maintaining the trade balance with India, even if the preference margins erode in the future. After all, the erosion of preferential treatment is imminent !

Shakya is Lecturer of Economics at Tribhuvan University